May

31

The local Singapore business paper had an article breaking down performance of local equities in various sectors. There is triple-digit performance in the construction sector, 40 to 50 percent performance in the finance sector and healthy rises across the board.

Swanky new nightspots are mushrooming and expensive cars are seen in greater numbers. Property sells for record prices with each new development. Recently there was a story of professional speculators who purchased condos to get on their boards in order to urge residents to agree to flip the entire building to a developer, essentially merger arbitrage in real estate.

From Ryan Carlson:

Yesterday, I just returned from a week in Singapore and am wildly bullish on it as well. So bullish that I'm planning on moving there in about six months and this trip was to help lay the groundwork for it.

Apparently, I'm one of many. The current cover of Time's Asia edition is on Singapore and the lead story is Singapore Soars.

In regards to construction stocks, besides riding along for the sharp upturn in local real estate values, I think it's a great way to play region growth as many have projects in China, Vietnam, Indonesia, and other countries where I wouldn't/couldn't invest directly.

The mention of expensive cars really is a great wealth indicator judging on how expensive it is to have a car in Singapore. I certainly won't have one once I move. An easy estimate is that whatever a car costs in the US, double it for there.

I strongly believe Singapore is the most dynamic place to live in the world today, and if I had to choose what investment I would buy and hold for the distant future, Singaporean equities, real estate, and the currency would be my choice.

Geographically, it's at the hub of three of the four most populous countries in the world (Indonesia is the 4th), which makes it an excellent place to watch developments in those other countries. No other place in the region can even remotely offer the quality of life or cleanliness and I firmly believe that wealthy citizens of India, China, Vietnam, Indonesia, etc, will all aspire to live in Singapore's cleaner, safer and more orderly society. If not full-time, then perhaps a pied-a-terre as a hedge against trouble in their homeland.

Regardless, the most important thing that will find a home in Singapore is capital. Private banking in the country has been a particular highlight as bank secrecy laws are in some instances stricter than in Switzerland. As the saying goes, "when it comes to large amounts of money, it's advisable to trust no one." And I certainly wouldn't trust the banks in other regional countries to hold a large amount of my money.

To help with inviting capital, Singapore offers favorable low tax rates, doesn't tax capital gains, and also provides numerous incentive programs including one aimed at attracting derivatives traders. I agree with the method of taxing consumption rather than income, which is generally how the system allows for a lower direct tax.

A reason why so many policies are correct in my view is that almost every Singaporean I've ever met was educated at a university overseas in the UK, US, Canada, or Australia. In turn, they take back home the best policies but also get a firsthand view of damaging policies elsewhere to avoid.

Those civil servants who enact and draw up policies in Singapore are some of the highest paid in the world. Although there is understandably some backlash to government officials paid so highly, I like how it retains those who would be bid away to the private sector. It's hard to take care of others if you can't take care of yourself first and the policy discourages corruption.

Quite often the mentality of Singapore is summed up simply with the word 'kaisu' which translates from Chinese into 'afraid to lose.' The small island has to compete globally in almost every facet and most notably with Malaysia in terms of many regional competitions. Because of the mindset and no shortage of competitors, Singapore will always have to continue the pace of development to drive the economy. Those in Singapore have built a tremendous global city through their ingenuity, and I hope that I can make my contribution by moving there myself soon.

Nigel Davies asks:

Why is Singapore considered to be a good place to live? Is it really freedom, or is there an unspoken 'biggy-like' respect for property rights? Here are some sample laws in Singapore:

Bungee jumping is illegal.

The sale of gum is prohibited.

Homosexuals are not allowed to live in the country.

Pornography is illegal.

As it is considered pornographic, you may not walk around your home nude.

Failure to flush a public toilet after use may result in very hefty fines.

It is considered an offense to enter the country with cigarettes.

Cigarettes are illegal at all public places.

It is illegal to come within 50 meters of a pedestrian crossing marker on any street.

If you are convicted of littering three times, you will have to clean the streets on Sundays with a bib on saying, "I am a litterer."

May

31

Bloomberg.com reports China's stocks rose, rebounding from a rout that yesterday wiped out $161 billion of market value. The CSI 300 Index gained 41.49, or 1.1%, to 3927.95 at the close, having earlier lost as much as 5.2%. It yesterday plunged 6.8%, the most since Feb. 27, after the finance ministry tripled the tax on share trades to cool a rally was drawing more than 300,000 new investors a day. "The government definitely doesn't want to see a big correction,'' said Howard Wang, who helps manage JF Asset Management's $443 mln JF China Pioneer A-Share Fund in Hong Kong. "What it wants is for local investors to think of returns as more symmetrical than they have been. If the market comes off 20 percent, then you're looking at a social issue.''

From government-administered resource markets in the USSR to government-administered financial markets is truly not much of a leap. Power corrupts and absolute power corrupts absolutely, said an illustrious British Prime Minister. It applies well today.

This reminds me of when the Hong Kong market went on to create its peak in the first half of the 90s and then the government was on the defending end of a hedge funds' selling blitzkrieg. Eventually the government came out a winner, having made enormous profits, but not before the market capitalization was cindered.

If such a thing plays out in China, which is unlikely given the cautious administration, it would be by some other handle the mistress would inevitably pull. As was true the last time it happened in Hong Kong, men with canes will be hobbling yet again in the financial marts of Shanghai.

May

31

It would take a Beethoven to do justice to the final triumphant rise in the stock market yesterday, the one that carried the S&P to an all time high of 1530.2 in the index, and 1534.5 in futures. Indeed, Beethoven could have written the ninth symphony about the last few days in the markets, with the long battle between minor and major in the first movements finally giving rise to the triumphal Ode to Joy at the end.

It was particularly apt and 'Beethovian', that the market had failed to eclipse the old high four times in a row the previous week, having spurted above it at the beginning of each day, only to get hammered down every afternoon because of concerted selling by bearish forces. Finally, yesterday, with the futures market at 1524 at 2:30p.m., the market rallied a nice ten points to finish at 1534 for the day — an all time high.

The rise was almost symmetrically opposite to Thursday 24th of May, when the market had rallied eight points above the Wednesday close, to 1532.5, and then promptly dropped 25 points to 1508. Yesterday, six calendar and three trading days later, the markets opened down nine points , dropped one below that, and then raced up 21, for a 21 point range (compared to last Thursday's terrible 25 point range on the down side).

Also 'Beethovian' was the way that the China downturn set everyone up to be bearish. Yesterday China tripled its trading tax, making it prohibitive for
anyone with proper knowledge of vig. to day trade, and the U.S. markets
once more went down a fast one or two percent in sympathy, but this
time only briefly. Recently of course, there was the February 27th, 58 point down day that happened on the first news of China trying to cool its markets down. Since that time, everything that looked like that day, as is almost invariably the case, has actually been a signal to buy.

The fake Doctor, with his cursory knowledge of the situation, blatant attempts to aggrandize himself, and his usual amateurish use of past patterns, has tried to gain purchase by 'bearing' the market down repeatedly over the recent weeks, with warnings similar to his original February 27th clarion. Each time he has tried, the day has started with doomsday activity, which has then given way to substantial rises, like yesterday's.

Also beautiful in its perversity and symmetry was how the announcement of the minutes of the May FOMC meeting led to an action completely the opposite of what occurred after the meeting itself.

Of course this is descriptive, and tests of markets that bounce back immediately from substantial declines, contrary to popular belief, show that the faster the excursion from big down to up, the more bearish it is. However, after an all time high, the statistics on the table favor up moves over a three to six month horizon.

There must be many bears who will finally throw in the towel now that they can't hold onto the mantra 'we're still in a bear market because we haven't exceeded the old highs.' The three main unexplored reasons for bullishness, which I wrote about over the weekend, still exist, and these are augmented by the tremendous and predictive gap between the earnings yield and bond yield of some one and a half percent.

There were also many other records set in the markets yesterday, like the Dax at 7847, a seven and a half year high, but still ten percent below its 1999 high. Google was at 498.60, almost breaking 500, and even Saudi Arabia was up at 7492, after a twenty day intra-day low of 7346. The Nikkei futures were at 17,865 at 2 a.m. New York time, with the three month high very close.

The amazing thing is how little the U.S. markets are up this year (approximately nine percent) relative to 100 plus other markets around the world. Markets are up approximately twenty percent in South America and Canada, twenty percent in Germany, and fifteen to twenty five percent in the typical Asian market.

As a final note, the fifteen positive sequences of 100 points in the Dow, with its new base of 13600, would seem to indicate a new regime. Of course there are markets that are up 100% or so, and they are vulnerable, but could those be pilot fish as to what the U.S. may go on to do? We are so used to meager gains and bearish scenarios, that one forgets how high a bull market can go. This is not a prediction but a remembrance of how much money I have lost by shorting markets that kept going up after seemingly bearish opens, like yesterday.

May

31

Today's all-time high close on the S&P 500 was first such since 3/00, about an 1800 trading day wait. In the past long-term highs were much more frequent, so in order to find analogous long waits (S&P 500 index 1956-07), conditioned:

Today's close is a 2000 day high, and there were no 2000 day highs for prior 100 days.

Then I checked return for subsequent 10, 20, 50, and 100day, as well as wait times between occurrences:

May

30

I'm fascinated by bubbles and crashes. They have a romantic feel, with all the theatrical elements reflected in a simple chart: enthusiasm, greed, madness, drama, fear, despair, and deception. My website has an entire section devoted to this phenomenon; I really believe that the study of these extremes can help us better understand the normal behavior of markets.

But enough theory! Japan small caps together with the GCC markets were the first bubbles to pop in 2006, and they haven't recovered since. The Mothers Index is probably one of the most manic-depressive of all markets I'm aware of. Since 2002 it has managed to climb from 500 to 2500 before falling back to 1500 in 2003, climbing back to 2500 in 2005, to finally loose 70% and counting. If you're looking for low correlations markets don't look further! But wait, I forgot to tell you that the bottom of 2002 was the terminal slot of a 90% freefall off its stratospheric 7500 peak in 1999!

Is this a sign of things to come in our part of the world? In spite of my general bullishness there are warning signs of sporadic irrationalities. How else can you name a struggling ex-dot com such as Artnet (Germany) that has an EBITDA of Euro 1 Mio and is valued at Euro 100 Mio?

But that's precisely the beauty of bubbles; they have this unmistakable flavor that brings out the best and worse of human beings. In the early stage you don't participate because you have decided that they are irrational. Then, after a rise of 50% you are still congratulating yourself, but you do have a little remorse for these opportunity costs. Then, after another +100% rise the elixir makes its way to your most greedy brain corners, and finally you decide to jump in (after finding the rational of course!). One of the most intriguing aspects of bubbles is that you make the highest returns precisely when nearing the peak.

Another fascinating aspect of bubbles is how they managed to fool everyone. Look at a chart of Deutsch Telecom since the late 1990s. What the Germans used to call the "Volksaktie" (the people's stock), looks more like a comedy than a romantic act. Actually, the chart does remind us of an inverted "V."

I wish I had kept all these useless analysts' reports on Deutsche Telekom (among others). They would have made for a great laugh today. But strangely they all disappear under some rug, no more trace in Bloomberg or anywhere. Maybe it's the invisible hand!

May

30

Today is only the sixth day since the start of futures trading in 1982 that the S&P 500 index set a new record close after five or more intraday failures, i.e., days on which the index at some point during the day was higher than the previous record close, but closed lower than the previous record close. S&P futures returns the next day after the previous five instances were mixed.

Seven years after the previous record close, today's record also ends the longest drought by far of new record closes since 1982. The index had a slightly longer dearth of record closes from January 1973 to July 1980.

May

30

It is notable that today the largest equity index decliner is not China but Peru, which at the moment is down 9.44%. The index is weighted heavily toward commodity shares, particularly industrial commodities.

A large part of today's move is generated by one particular stock, SMCV PE. Nonetheless, I think these sorts of developments should be watched as having potential implications for other similar and correlated markets. Specifically, does this say anything about what has been a seemingly endless demand for commodity-related assets, stocks, currencies, physicals, etc.? What implications might this have for particular countries, both pro and con, that both export and import these products, such as Australia, Chile, and South Africa, etc?

From Luca Coloso:

The Peruvian index has done +168% last year and today's fall included +41%. This is catching the attention of the locals who are speculating mindlessly. My wife is Peruvian and was telling me that one of her aunts, who has never invested in the stock market before, just last week was recommending strongly to her daughter to get a loan from the bank and invest in the market.

I don't think this needs further comment apart from the public's need to lose more than necessary, the system's upkeep, and the perils of a heavily "commoditized" market.

May

30

I was reading Da Vinci's notebooks recently, and was intrigued by his method for learning to paint. I thought it might be interesting to try to adapt his model to learning to trade. I'm not sure how useful my little Saturday afternoon research has been but it was fun. Listed below is the sequence Da Vinci recommended for young men to learn how to paint, followed by my own interpretation of the general learning outcomes, and then their trading applications.

Leonardo Da Vinci's model for learning to paint, from his own notes:

1. Imitate a masters work — best to imitate an antique.
2. Draw objects from relief but not from memory.
3. Familiarity of the human form — seeing each muscle in every possible position.
4. Do stick drawings from nature and expand them at home.
5. "Thus I say to you, whom nature prompts to pursue this art, if you wish to have a sound knowledge of the forms of objects begin with the details of them, and do not go on to the second [step] till you have the first well fixed in memory and in practice."
6. Keep the company of people who share the outlook of being mirror like in their observations. If such people cannot be found then keep your speculations to yourself.
7. "I myself have proved it to be of no small use, when in bed in the dark, to recall in fancy the external details of forms previously studied, or other noteworthy things conceived by subtle speculation; and this is certainly an admirable exercise, and useful."
8. "Winter evenings ought to be employed by young students in looking over the things prepared during the summer; that is, all the drawings from the nude done in the summer should be brought together and a choice made of the best [studies of] limbs and body."
9. He is a poor disciple who does not excel his master.
10. "Some may distinctly assert that those persons are under a delusion who call that painter a good master who can do nothing well but a head or a figure. Certainly this is no great achievement.
11. "Nature has beneficently provided that throughout the world you may find something to imitate."
12. The mind of the painter must resemble a mirror.
13. "When, Oh draughtsmen, you desire to find relaxation in games you should always practice such things as may be of use in your profession"
14. "The sorest misfortune is when your views are in advance of your work."

General Learning Statements:

1. Copy the work of someone who has done great work before.
2. Copy the actions of a master.
3. Look at each part of the work and see every permutation and how it fits with the other parts.
4. Do basic models of the whole process, to practice.
5. If you wish to have a sound knowledge of the task or subject then study the details and memorize them and practice them.
6. Don’t become clouded by other peoples views and thinking processes.
7. "I myself have proved it to be of no small use, when in bed in the dark, to recall in fancy the external details of forms previously studied, or other noteworthy things conceived by subtle speculation; and this is certainly an admirable exercise, and useful.
8. When 'out of season' you should study past actions and commit them to memory and learn from them.
9. Look to excel past the people you learn from, but without arrogance.
10. Always learn and practice all elements of your skill.
11. Look in other areas of your life and world opportunities to learn and transfer observations to your study.
12. Only observe.
13. Make games that will help you learn better your skill.
14. "The sorest misfortune is when your views are in advance of your work."

Stock Market Learning:

1. Read the works of Soros, Jesse Livermore, William O'Neill, Warren Buffett and Nick Darvis.
2. Choose one and copy exactly what they do.
3. See each stage they go through to reach their conclusions and the actions they take and the inferrences they derive from the outcomes.
4. Pick stocks and plan out the course of action and all the permutations of what will happen in all price scenarios and put them into practice.
5. Memorise the details of the great coups and all the rules the masters have made in trading.
6. Keep all your trading a secret and don’t let others' views interfere with your own. Keep your mind totally on the facts at hand and the details of what you see.
7. Before going to sleep look at the coups of other traders and of your own. Talk with the masters you are studying and meet them in your mind for interviews.
8. When the markets are not open or the market isn't acting right for you then study past trades and memorise the actions you took and piece together the trade again looking for the lesson.
9. Be a better trader than your teachers and ask yourself how you can do better.
10. When you have practiced and 'perfected' position entry, move to exits, patterns, money management, probability theory, etc..
11. Look at situations and look at them as you would a trade. What would you do? Are there any interesting things to learn here that can be used in the markets?
12. See what's happening rather than guess.
13. Play games like the one played in Liar's Poker, where you invent scenarios and ask each other what you would do in that situation. E.g. nuclear explosion in Tokyo…
14. Be aware of views you are taking on a trade. Look at it always as if it’s the first time you have seen it and review an open trade every day as if you have just placed it.

May

30

I have made a few comments in the past suggesting the need to separate the commercial markets (commodities, fixed income, and FX) from equity markets when considering fixed systems. As an unrepentant fixed system guy, I would argue this is correct; there have not been many trends in commercial markets. Ten-year yield is about where it was in late 2003, as is the dollar. Commodities have moved up but when the carry is taken into account the move is modest. There is evidence of lack of movement in the volume levels of bond and FX options in particular.

This is, however, the ideal environment for Equity: stable rates and currency. As is the case with all diversifying asset classes, they are loved in research and hated in practice because they lose money when they are supposed to.

Steve Ellison writes:

There is a good reason why businesses try to minimize inventory using just-in-time processes. Holding inventory results in four types of costs, collectively known as inventory carrying costs:

Cost of capital tied up in inventory

Cost of storage space

Risk of loss

Risk of obsolescence or spoilage

In business, annual inventory-carrying cost rates are often estimated at 20% or more of the purchase price. For this reason, most business owners would consider buying and holding commodities a strategy for destroying business value, not enhancing it.

Over the weekend, I looked at the financial pages of the New York Times dated December 15, 1961. It was surprising how little the prices of some commodities have changed since then, even without considering inventory-carrying costs.

May

29

The USA is by far the top global destination for economic migrants and political refugees. The notion that we're hated is absurd and countably false. That foreign elites with hands on bureaucratic and media levers hate the USA, for easily understood reasons of envy and competitive fear, is equally obvious.

USA elites who wish to subsume American power into a global cauldron of "expert" rule, simply exaggerate the nonsense spewed by their overseas sympaticos.

David Wren-Hardin responds:

In some ways I agree with the critics, though not to a great degree. But if everyone in the world is against us, why did France just elect a president who ran on a platform of increased cooperation with America?

Shui Kage replies:

I am not aware of any French military cooperation with the US in Iraq. If the new French president has decided to do so, then I cannot understand why the French elected such an insane president.

Marion Dreyfus remarks:

The US is envied and lusted for. Big Bro is so powerful it dwarfs the modest claims of the littler countries. And France's new president is not "insane" because he professes more support for a country that has in the past done a great deal for the people of his modest state.

Chirac was a nasty bit of work, and we are deserving of a man whose raison d'etre is not hatred of the US for no particular reason other than to regain the Sun King reputation France lost so very long ago and has been striving to recapture foolishly and with an ugly complexion.

Stefan Jovanovich adds:

I don't think that we Americans should spend much time being unhappy about the world press's not liking us. We are the only country that has the military capability to destroy every major city on the planet. That is hardly the kind of power that makes people want to say nice things about you. China has been bent on expanding its "sphere of influence" for quite a while. Notably, its East Asian neighbors are pushing back. Taiwan, South Korea and Japan are all undergoing major military expansions in their naval and air capabilities. On balance, the Chinese, even with their expansion, have less relative clout in the region than they did five years ago. Then, political reunification seemed a distinct possibility for Taiwan, given the presumption of China's military dominance. One does not need to like the Russians to concede that, from their point of view, enlarging NATO and establishing military bases in Central Asia could be seen as threats to their diminishing territories. But there is little the Russian Federation can do except bluster. The decline in the capabilities of the great conscript People's militaries of the Marxist world (first China, then Vietnam, then Russia) is the most important change in the past third of a century. Then, the U.S. had trouble invading the island of Grenada, and the Soviets could, simply by hinting at their strategic capabilities, force the IDF to let the Egyptians walk away from the east bank of the canal. Now, both the Chinese and the Russians have extreme difficulties in attracting even half-bright people into their militaries. They know that conscription does not work, but they have no ready alternative to it. They both have the money, but they are not willing to spend it. Both the Russians and the Chinese think their foreign currency reserves are more potent weapons than an all-volunteer military.

May

29

The Soros piece about the Palindrome's predictions over six months got me thinking about the talents really required for short-term trading. This brought to mind a Philip K. Dick short story entitled The Golden Man.

The golden man of the story is really nothing more than an instinctive hunter-gatherer. But he has three unusual abilities that mean that he will not only be invulnerable but that the existing species of mankind will inevitably be wiped out and replaced by his kind. These are short term clairvoyance, speed, he is irresistible to women.

Now what better qualities could a day trader have? Within a few years he could accumulate huge wealth and ensure that his genetic tendrils dominate the world's gene pool for millennia.

Who needs economics?

May

29

"If those newspaper correspondents who take so much pains to vilify men who are engaged in fighting the battles would shoulder a musket and go into the field themselves I think they would do more to advance the cause, than in pitching in undiscriminately as they do." - W.R. Rowley, Head Quarters Army in the Field Near Pittsburg, Tenn. April 19th 1862.

It is truly wishful thinking to believe that newsies will ever "advance the cause". It is simply not in the nature of the beast. The news of war is almost invariably wrong because it comes from one of two sources: (1) those far away from the battle and (2) those who ran. Rowley himself knew this. In the same letter he writes,"(M)ost of our troops behaved well but some of the raw regiments broke and run and among them their officers. (Hence) (t)hese stories you hear emanate. (I)t is necessary that they should have some excuse for their cowardice and the best way to direct public attention from themselves is to direct it in some other course."

In less than a decade it will be the centenary of the Battle of the Somme. It is unlikely that the battle will be seen as anything other than dreadful, wasteful, and horribly sad. What is certain is that no one will celebrate the battle for being, like Shiloh, the beginning of the defeat of a brave but wrongful enemy. Both the Imperial German and British troops who did the fighting thought that the battle was the turning point of the war: that, for the first time since the end of the Battle of the Marne, the Germans had lost.

When the commemorative speeches are made in 2016 the verdict of the soldiers themselves will once again be irrelevant. Everyone except for the people who were there will know that the battle was a completely unmitigated disaster just as the news accounts and the histories written from them have always said. That will be, as it always is, the ultimate insult from the survivors. Those who did not fight will get to teach and preach the lessons of war.

May

29

As much as I was fascinated by Mr. Soros's description of market mechanisms and his reflexivity theory, I found his analysis flawed and mainstream when he begins to make long-term macro-economic predictions.

Now that's funny. One of history's most successful fund managers turned out to be wrong on most of his long-term predictions: the decline of the US economy, the rise of Japan as the next superpower, the Imperial cycle, etc.

So how can it be that someone who was wrong on so many predictions turned out to have generated such amazing returns for so long? Could it be that the achemy is nothing more than a great camouflage?

I see brilliant economists who are very accurate in their long-term predictions and present analysis, but somehow they can be lousy when it comes to managing money and "be right" within a tolerable time-horizon. On the other hand, I see brilliant fund managers who, I think, are lousy economists; maybe for the better, their success can't necessarily be attributed to what they believe is the true cause.

Mr. Soros's understanding of market characteristics (rational and irrational) and of markets participants is undeniable. And that, combined with a form of intuition, could be his main strength. Most important, he is very successful at "being right" within the next six months, which is all that matters for most investors! How it is packaged for the public and is a different matter.

Riz Din adds:

I formed a very similar opinion after reading Alchemy. I find it astounding how someone's long term convictions can be so off base while his trading produces super profits. After reading the insightful trading-diary portion of the book, I concluded that his strengths lie in his not trading based on his long-term views, but rather listening and reacting to the market on a day to day basis. His somewhat stubborn bearishness seemed absent in the day-to-day trading mode.

May

29

It should be noted that investment grade bond domestic bond issuance set a monthly record as of Friday, with borrowers selling $105.92 billion in securities (and the month isn't over, with three full days remaining.)

Among the commentary supporting the debt binge, equity strength is highlighted, as well as the perception that despite the aggressive pace of LBO/PE deals. The thinking is that it will be a quite some time until a high-profile deal melts down. Moody's agrees, apparently, with a report issued last week forecasting a decline in default frequency to a record low.

And the proceeds? S&P 500 components have spent more than $440 billion on share repurchases over the past 12 months, according to J. P. Morgan.

Alston Mabry writes:

Having spent a while recently as a spectator at a PE buyout, from the acquirer's point of view, I can offer this observation from the cheap seats. The PE craze appears to be fueled, just like the hedge fund industry, by cheap leverage. The buyout firms are using leverage at 5% to buy cash flow of 10% and pocketing the difference. On a $5B deal, that's $250M/year. And if a few years later somebody comes along and offers you a price you can't refuse, like Riverdeep did for Houghton, then so much the better.

So where's the weak point? Or is it a free lunch? If there were to be a downturn that pushed too many of those cash streams negative, but still the interest payments on the leverage keep coming due, then could some buyout groups get hurt?

Stefan Jovanovich comments:

I doubt that where we sit qualifies as "seats". Even calling the location a knothole in the fence is probably an exaggeration for our odd-lot venue.

Over the last 12 months the return on common stock investments net of commissions before taxes was 19.65%. The pre-tax, post-expense return on our private investments during the same period was twice that - 38.52%. Alas, no one is eager to buy that private cash flow with or without leverage because the world of finance capital for small private businesses here in California no longer exists.

The roll-up boys are long gone and so is small business lending unless you include your Capital One credit card in that definition. The returns on small business equity here in the Golden State will continue to be outsized because there is no way for going concern values to be monetized. No one in their right mind wants to acquire legal employees unless they have already amortized that risk with a full-blown HR department.

If our situation is at all typical, then the flow of capital from small business owners into securities may have a great deal longer to run. We make a great deal of money from our private business, but we know that every new investment in it is truly sunk. We can only get a return from operations, not from selling.

Philip J. McDonnell writes:

In a way the return on private equity is higher than the publicly available equity. With the advent of Sarbanes-Oxley the costs to comply went up for public companies. It simply added costs to their operations with no compensating income gain for the companies or the investors. In addition to that there always was some kind of added cost borne by public companies. As usual the regulatory costs only ratchet upward never down.

With the example of a public company with a 10% return (PE=10) which is purchased for money that was borrowed at 5% giving a net 5% after interest cost return, the real situation may be better. In fact given the regulatory savings the newly private company may be able to yield 11% thus boosting the net return to 6% which is a 20% better ROI.

The benefits do not end there. There are no margin calls in private equity. Contrast that situation with a typical highly leveraged hedge fund. The hedge fund can borrow too. But if it is trading marketable securities there will be margin calls. Typically the portfolio will be marked to market daily and immediate liquidations will ensue if the value falls below minimum margin requirements.

For a private equity firm there is no daily quoted valuation. There is only the book value shown which is typically a high and inflated number set at the time of the buyout. The lender is actually looking to the cash flow more than any vague concept of market or portfolio value. Lenders want performing loans. To them performing means the borrower is repaying as agreed. It is capitalism as it was designed to work. When the government finds ways to regulate and to restrict credit the markets find ways around it. Ultimately the markets will rule.

May

29

What can we learn from shelled species about the markets? Shells protect creatures from predators, wind, sea currents and the sun. Sometimes they are conical, sometimes circular, and sometimes spiraled, with each shape being specialized to its particular purpose. Why do shelled creatures often live for so long … and in the markets, what makes some stocks live longer than others?

Reputation is key to business success, with companies spending fortunes to keep their reputations up, so that customers will pay more for their products. How does the market use the reputation effect to maintain its feeding webs, with particular reference to the last period effect, where there is no current incentive for a politician or market to fool its voters or votaries?

The Japanese and Israeli markets are both up sharply this morning, from when the U.S. markets closed at the end of last week. To what extent has there been correlation of these market's moves to the U.S. markets' move on the following day? My hypothesis is that the correlation was weak until last year, but has increased recently.

There has been a much greater tendency to reversal after big moves lately. Is this indicative of a change in regime or tempo, or is it bullish or bearish? The risk premium on stocks, according to a cursory study transmitted to me by the sapients at Gavekal, is at its historic average, but the risks nowadays from the economy are much lower than they have been before. To what extent is this bullish or bearish also?

It is an old saying that a nation's preferences in sports reflects its character. What can we say about the changing nature of sports in the U.S. that is indicative of future market moves? Is it truly hard to find kids in the ghetto playing basketball these days, and families visiting national parks together, because outdoor pursuits have been crowded out by computer games, etc.? If true, what are the implications of this for amusement park companies?

The ten year bond is a tenth or so away from a five percent yield? Is there a gravitational effect towards the round number, and will this have a detrimental psychological affect on stocks, with the yield differential still being at one and a half percentage points.

When will all the remaining trend followers get tripped into being long the dollar, and will the increased movement in the dollar's favor lead to another opportunity for the banks to make money from going against such a fixed position?

As a final thought, some old men are the greatest repositories of wisdom for the younger generation, like Ed Marks who was the greatest speculator I've ever met, or Larry Leeds, who has the best record of all for institutional funds. Others, (like the weekly financial columnist and the Nebraskan), have a message, that if followed would lead to lassitude and mediocrity.

May

29

Men and women born just after WWII are soon reaching retirement age. Interest income is important to retirees. They can't depend on volatile markets. They require something fixed, sure, a financial instrument that keeps food on the table, will pay the doctor, dentist, pharmacist, and funeral director.

There is more on the Fed's table than inflation and unemployment and corporate profits. Financial institutions and insurance companies for instance will be looking for yields that accommodate these needs.

Long bonds support fixed income; these yields must not fall if the future of retired voters are to be accommodated. A yield of 5%, in my experience, is insufficient to cover present inflation. How are retirees going to make out? The Fed is not independent from political and cultural forces. They will create a favorable situation for baby boomers. How does that affect stocks?

Stefan Jovanovich replies:

The first retirees in history were the merchants, schoolteachers, ministers, army and navy officers and imperial civil servants who lived into old age in the last third of the 19th century in the United Kingdom. They were the customers for the annuities that British insurance companies began selling in large numbers; they were also the audience for Gilbert and Sullivan.

The insurance companies looked to the bonds issued by the governments, railroads and utilities of the U.K. and the imperial territories, principally India. The recent anxieties about new home sales and re-sales and Congress's eagerness to "fix" the mortgage market suggest that the funding for the promises sold to American retirees is more likely to come from mortgages than bonds.

This does not answer Ken's question, but it may dampen some of the enthusiasm for finding in Great Britain's recent history the analog for America's predicted imperial decline.

May

28

The world of movies and the culture of America have been different ever since Star Wars. I remember that I was 13 years old and finishing up the 7th grade, thinking about summer baseball and how I had been invited to play for an elite team of graduating seniors and seniors to be. I was looking forward to summer camp, and girls were definitely on my mind, the possibility of seeing Rachel, or Beth in a bikini.

I remember Mr. Russell, who would become Coach Russell, and later my friend Mike who now works for me and home-schools my kids. Mike would pick me up two nights a week to go play basketball with the adults and high school kids at the local gym.

I remember one night our church youth group decided to go to the movies. That was when I saw Star Wars. Yeah, it was pretty cool! I had hair that nearly went down to my shoulders back then. Now, well let's just say that things have changed. But that boy inside of me is still there. And memories like this bring him back and I feel young again!

May

28

I've written many times about hunting and how much fun we have as a family with hunting, fishing, hiking and spending time together in the outdoors. The hunt itself is only part of the fun. The preparation and practice are a blast.

My 8-year-old son, Hunter is really into shooting his bow. He's addicted to what Ted Nugent calls "the magical flight of the arrow". After practicing with him today we searched YouTube to show him some archery tips.

We came across Byron Ferguson's Incredible Archery Shots. There's a whole series of them on YouTube. They are all around a minute in length and definitely family friendly. Take a few minutes and watch a few of these videos and bring the kids in the room. Who knows? You too may become entranced with the mystical flight of the arrow.

May

28

There is an interesting one page article by April Frawley Birdwell that appeared in the Winter 2007 edition of the University of Florida Alumni Magazine, on theoretical ecologist, assistant professor Ben Bolker.

From the alumni magazine article (not seen online), Dr. Bolker "uses math to develop models that answer the 'what if' questions in ecology".

"Bolker's field, theoretical ecology, sounds abstract, but he describes it more simply as ecological modeling. He takes data other researchers collect during experiments and devises the mathematical means to answer questions the results cannot answer alone, mostly about the population patterns of plants and animals. He also tires to answer ecological questions of the hypothetical sort derived from his own brain. This can help researchers know what type of data to collect, he says."

Bolker is preparing a book for publication which may appeal to the statistically and programming-inclined. Evidently the book is meant to provide a more technical background to information set forth in Hilborn and Mangel's Ecological Detective.

Bolker's forthcoming book can be found in draft form. He welcomes feedback (he does come across as a fine teacher and one willing to help his students "break down math barriers").

May

28

I have no problem with advertising. It is essentially freedom of speech, a right. How else do people find out about a product or service?

Coke does it, Microsoft does it, Nike does it, I've done it. The larger issue is, does the sales message fairly present the proposition? Ken Smith has led the charges on this point.

Considering the large cost of advertising it is natural to try to get your ad cost back so a legitimate promoter will be as enticed to get a response as a huckster.

It is one thing for a money manager to advertise vs. a letter writer or educator. They have different markets to attend to. Some prefer writing to trading. A few trade and write. Then there is the running of a money management firm (that takes a very sharp business person as there are numerous areas of expertise needed beyond trading).

The aggressive promoters always have a back end. They want to sell you a book for next to nothing. Then a campaign steps up to a very expensive service or personal mentoring. That's the one they are doing now.

Several of these guys have approached me telling me how they 'step' people up from a free seminar to eventually getting $20,000 from them.

That galls me, as I'm sure it does most people. I'd rather trade or promote myself, (brag like hell of course if that's what's required) but have full disclosure and no hidden agendas.

Perhaps this will alert some to the mentoring hustle going on in the world of trading now.

May

28

On the wealth-effect, I've been Googling for investigations on the effect as self-reinforcing feedback mechanism and I can't find anything of note. Most of the material I have come across refers to the wealth-effect as a two-step process (rising asset prices increase wealth that equals more spending).

However, as the Chair notes, a portion of this wealth-related spending will be on a variety of assets, whose prices then inflate to generate further wealth, and so the wealth-effect transforms from a two-stage process into a reinforcing cycle.

May

27

The Traveler's Dilemma and Prisoner's Dilemma are two examples of cooperative-competitive games. They contain aspects of reward for cooperative behavior and rewards for competitive behavior. In the Traveler's Dilemma game picking a higher number is cooperative play. The player is maximizing the reward to the two-player community. Picking the low Nash Equilibrium is competitive play. The player is maximizing the minimum reward. Naturally as the reward for competitive play increases the number of actual players using competitive strategies increases as well.

There is a strong parallel to the market. If we all buy stocks with all of our money they will go up. The community of investors will all gain. But human nature being what it is we will always be at least somewhat fearful that someone else will sell first and we will be the last to get out. Thus based on a news event or even non-news some will choose the competitive choice to get out early. They seek to avoid the maximum risk of a putative future decline by getting out before the other guy. However the long-term drift strongly indicates that such anti-cooperative behavior is self-defeating and leads to opportunity loss.

May

27

I can assure you that American boys and girls join the military to fight. We told our parents it was for the education, money, or to see the world. Yet the fact remains we loved to blow stuff up and be soldiers. Nowhere, in any business or sport, are young men and women age 17-22 afforded such responsibility with powerful equipment or in such a strong leadership position with the chance of quick promotion than the military.

For a soldier, after about six years in the military you hit the decision maker. That is when the people in the civilian world start making much more money. For an officer, do you want a company command, take a corporate job, or start your own business? For the enlisted, do you want to be a platoon sergeant, work with and lead men for the next 15-20 years then retire and start your own business with the military retirement check?

It may come as quite a shock to some that there are millions of Americans that do not care about money. The Army has quite a retention system. The lifers, those that are in the Army for a career have a passion to retain those soldiers they feel are best, to promote their own love of a career.

I still remember the quote from Mel Humphrey. He was the meanest SOB to ever walk this earth. He thought it was his duty as an American to take young kids and teach them how to work. You had two choices, his way (the money) or join the military. He paid such high wages; I made enough working for him at 16 to work 4-6 months a year and race the rest of the year.

One of my first days at work we had a long drive to the job site. It was snowing and we were prepared to work 12 hours. In the pickup truck freezing my tail off he smoked like a chimney so I had to keep the window open. I peeled off my gloves as he said, "write this down now."

How long does it take to drive to the job? Leave early to miss traffic and eat near the job site?

How long does it take to use the bathroom? Fifteen-minute breaks are 13 minutes too long.

How long does it take to each lunch? Eat while you work and it's a paid lunch.

How long does it take to plan a job? Take twice as long and you'll save double the mistakes.

How long does it take to clean up, pick up tools? Take the cost of lost tools and time to replace them into account when your cold tires and just want to go home.

How long does it take to get home? Slow down, tickets and accidents on the way home kill.

Out of a 12-hour day, driving-planning how much actual work gets done? How organized are you for the crew and how many actual man-hours of work are completed every day? Keep track.

Now what is your best guess to make (how much you want to make a month) what is your guess on how many hours you will be working.

You have a girl friend? Good because once you have it figured out how much work you do, the time and effort it takes. Realize you need to love your job and those you work with as much as any woman you marry. You'll see your work more than your wife.

All the while he told us crazy military stories. There was no money, a lot of BS and down time. Yet you had the opportunity to do things that were impossible to do in the civilian world. You want excitement? Join the military. You want money, "get back to work."

May

27

Last week I attended a project management course called Prince2. It was very interesting, but also challenging. The written exam lasted about three hours. At the end I was exhausted. The questions were difficult and you had to manage your time very well.

English is not my mother tongue and may be this is also why I got so tired. The instructor asked me: "How was it?" I said, "Very difficult. I am not happy". The reply was, "You are never happy. You are a pessimist".

Perfectionism, is often confused with pessimism. In the end he was right from a certain perspective. You do not live well always looking to "the next step" in order to improve your results. Traders must be optimists because they must be confident in their system when they take risks. Optimism does not have to be confused with superficiality - "things will go fine anyway".

The optimist looks at the next market move confident that prices will go in his or her direction. A pessimist will never start trading because the improvement process will continue forever. A pessimist will work out the details and analyze risks thoroughly. A pessimist suffers during trades, projecting reversals and fakes to his positions. A balance should be found.

I think, however, that the approach should become as mechanical as possible to leave out emotions and attitude. A tested approach has to be followed with discipline. A trading methodology should be designed, tested, and applied in a scientific and mechanical way leaving the human factor out of the game. I am not sure how intuitive traders can do. The validity of their approach is not measurable, although their results in the long term are. And there are many successful intuitive traders out there.

From James Lackey:

Perhaps the reason "emotion and attitude" get a bad wrap is they're not measured and tested. In hindsight all bad trades were due to "emotion and attitude." What about the good trades? Are good trades always entered with the so-called proper no emotion and humbleness? Of course the proper way to exit a good trade is with reasonable humility.

Discipline is only good after the desired result. Discipline with bad results is insanity, doing the same thing over and over expecting a different result.

I have seen a few mechanical traders fail. After the fact they might blame their interference for their demise. After pointing out their system wasn't good enough in the first place, they argue that, no it was their lack of so-called discipline for not sticking with a winning system. Yah, right. If the system were winning big the emotional response would be to go out and celebrate or promote for even a greater monetary gain off a bigger stake.

May

27

I just now decided to have a late night Big Mac and pulled into our local McDonald's and noted they were closing. I hurriedly pulled to the drive through and placed my order. I got to the window to pay and was told the grill was shut down and I could get my # 1 with a Big Mac, but it would be made with a quarter pound of meat. I said that was fine. I got back home and found they had included a second burger at no extra charge.

I like McDonalds anyway, but that little extra tonight is good PR and keeps customers happy and thus helps McDonalds stock.

Many years ago one of the first McDonald's opened up on Hamilton Road in Columbus. My mother's sister and her husband lived in Columbus and took us to this brand new restaurant. I was probably 10 and can still remember the golden arches that I saw for the first time. At that time they had single burgers with ketchup and a pickle for around 29 cents. They came wrapped in paper. Hard to beat that occasional Big Mac, hot fires, and a cold Coke, as American as apple pie.

Ross Miller adds:

Despite Ray Kroc's best efforts, McDonald's quality varies widely from store to store (I am reluctant to use the word "restaurant"). I once considered the better stores to be reasonable places to eat, but my tastes have changed (I hope for the better) over time.

My current favorites in pre-fab food are four regional chains that have settled into the Albany, NY area on an experimental basis. Here are some quickie reviews in descending order of quality:

Carrabba's: Ersatz Soprano eatery. Surprisingly good and an okay "date" restaurant that pegs one with a net worth of under $25 million — so some dates may object. I am a regular so the help knows that I will have them executed in the parking lot if I have to wait for anything.

Nothing but Noodles: A good date restaurant, seemingly from Arizona, for the sexually ambiguous. The name is a misnomer. I'm a regular there too but turnover is so high no one has noticed. Southwestern style noodle dishes are amazing by local standards. Free Wi-Fi, but happily few use it. Don't look too long at the other dinners or a Zoloft/Merlot chaser may be necessary.

Five Guys: Great authentic DC area hamburgers and even better French fries. Not a date restaurant unless your net worth is over $1 billion. Free peanuts are a bonus to attract the hedgie crowd. Now open at National Airport, though eating is the last thing on my mind when I'm staying there so I have no idea how the food is at that outlet.

Moe's: Upstate New York's weak attempt at Una Mas, a great Bay Area burrito place. Makes me miss California a whole lot. I am a regular there and they yell "Happy Monday" whenever I walk in. I am probably their version of Stevie, which is really sad.

May

26

Amidst the bearish and bullish voices of present, there are three subjects that I believe are important which have received little consideration:

1. The tremendous hedged long/short (both direct and indirect) pool of funds still trying to capture an alpha of a few percent, that has not bought into the 10% a year rise in stocks. There is also considerable capital with the foreigners who either hate Bush, or are just uninterested in the US.

2. The moves to cut taxes all over the world, as countries try to compete with China where they have no capital gains tax, and an income tax of 15% (there is even talk of abolishing this).

3. The incredible increase of wealth in such things as real estate and equity holdings, as well as firm values, mutual fund values (and a dozen other such 'values' that are indirect signals of the US's great wealth), collectibles, investment in intangibles such as patents, education, or brand names, and improvements in homes. Also, spending in the stock market due to the Wealth Effect has increased to an inordinate extent, and there has been great rises in almost every other stock market around the world, offering great untapped reservoirs of liquidity. I believe that the much denigrated and unstudied Wealth Effect is a greater source of spending on stocks, and a driver of stock values, than the normallly used Income Effect explanations, that economists and officials of the doomsday persuasion like to pay attention to and study.

May

25

My favorite holiday of the year is Memorial Day. This is the day when I remember the freedom that I have and how it was won. It is the day when I give deep and sincere thanks to those who fought .. .not for my freedom (I would never ask anyone to do that), but for their freedom, and for the freedom of their children.

I remember that the freedom I have and enjoy is a by-product of other people's willingness to fight for what they believed in. Over the course of this weekend, we'll hear a lot about the sacrifices of these men and women, but I don't think about what they did as a sacrifice — I believe that what they did was simply a matter of choosing their highest values.

I doubt most sane people want to die, but there are those that choose to "walk into the valley of the shadow of death" so that they may have that which they value most; freedom and liberty.

I was thinking about baseball today also. I remember fondly my carefree years of youth, playing baseball and wishing I could some day play in the big leagues, and I remember having players that I idolized. One in particular comes to mind, who was introduced to me by my father, and whose career had ended two years before I was born. He was Stan "The Man" Musial. What a player! What a career! What a person!

I was also thinking about all those who are about to enter what used to be an elite club; the 500 homerun club. I began to wonder if Stan Musial feels he had sacrificed something as important as the 500 homerun club to serve his country? His actions and life lay bear that myth. I can't read "Stan's mind, but he strikes me as one who is contented with his place in history. I'll always think of him as "The Man", who gave up a full season in his prime to serve his higher values.

I don't want to forget my A.L. friends either. There is a player of great renown who likely would have made the 600 homer club if he had not choosen to serve his higher value: Ted Williams hit 521 homeruns but also served our country's military for several prime years. Here's what wikipedia has to say Ted:

Williams served as a United States Marine Corps pilot during World War II and the Korean War. During World War II he served as a flight instructor at Naval Air Station Pensacola teaching young pilots to fly the F4U Corsair. He finished the war in Hawaii and was released from active duty in January of 1946; however he did remain in the reserves.

In 1952, at the age of 34, he was recalled to active duty for service in the Korean War. After getting checked out on the new F9F Panther at Marine Corps Air Station Cherry Point, North Carolina, he was assigned to VMF-311, Marine Aircraft Group 33 (MAG-33) in Korea.

Many men and women have given their lives and limbs to fight for their highest values, and I highlight these two only as reference points.

I think that the real spirit of Memorial Day is best summarized in the words of one of our Founding Fathers:

Is life so dear, or peace so sweet, as to be purchased at the price of chains and slavery? Forbid it, Almighty God! I know not what course others may take; but as for me, give me liberty or give me death! — Patrick Henry

My friends, remember this day and what it really means … and everything it took to get where we are today! Remember the words of Patrick Henry as you relax, comfortable and safe, and maybe take in a ball game.

I will end by saying this: thank you to every man and women in this country who has served in our military. To my friends who have served (and there are many of you), I want to extend a warm and sincere thank you to you personally. If I could, I would shake your hand and give you a hug, I am truly grateful.

May

25

Remarkably, each of the four days this week the S&P Index has traded above its previous all time high close of 1527.9, but then failed to set a new closing record.

Day

High

Low

Close

Mon

1534

1526.6

1527.9

Tues

1533

1525

1525

Wed

1535.7

1524.3

1525.5

Thur

1532.5

1507.8

1511.6

Note the artful way that the market was able to be down on the week by a hair, as of Wednesday, setting up the longs to increase their positions, only to decline 25 fast points the following day. It would take a Rommel or a Stonewall Jackson to duplicate such cunning.

Thursday had the highest single day range since March 21st; it was up seven by 10 a.m., but then down 18 by 3.40 p.m. (NY time). This is about two and a half times the average range of last year, and shows the usual ability of the market to do the unusual.

Finally, there have been four serious down afternoons, and these are presumably related to the fake Drs. feelings about China … let us hope he visits there for a second time soon, as the first time he was only there for a day (with Paulsen, just 1 year ago).

From John Floyd:

I think other contributing factors to the market's retreat are also tied to the cycling of rate expectations, economic data, and "carry trades." The beginning of yesterday's sell-off started not soon after the stronger U.S. economic data and coincided with a sell-off in interest rates and carry.

In addition to the Dr.'s comments, who does seem to be losing some of his "mojo," the directive of the latest comments were towards China and the market has disregarded the comments and moved to new highs since them. The overnight price action in carry and Japanese inflation data continuing to border on deflation should make today interesting.

Also of note, combined with other indicators, is that gold last Memorial Day was at roughly the same level and subsequently fell sharply.

From James Sogi:

Why three times? It's like the old knock, knock joke. Who's there? Always three times of course. Three is the minimum number to create a pattern. "Knock, knock. Who's there? Orange you glad I didn't say banana?" The three tops were also the three-mountaintop candlestick pattern. Seems like the market likes threes. "On your mark, get set, go!" Seems like something deeper, but what? But it's something to ponder over a three-day weekend.

It's great for sitting on the deck because you can eat holding the little stick and still have a free hand for the beverage and you can gesticulate with the little stick to make your points more emphatic. Serve rice of course, or better yet Musubi. Here's how to make Musibi.

From Dylan Distasio:

If you're in the NYC area, check out Yakitori Totto on the West side for awesome organic yakitori and a great sake selection. They actually have an East side location also. My wife and I have eaten at both fairly often, and the food is delicious. They cook most of it over the long slim charcoal grill on skewers, and you can order any piece of a chicken you can imagine (and then some). It's fun to just order an assortment of small skewers and drink some sake. There's a great atmosphere also. I've never been to Japan but it seems pretty authentic. We're often one of the few Caucasians in there; the rest are usually all Japanese-speaking, including the entire staff. I'd highly recommend it.

John Floyd adds:

Actually if you want sake and good food the other place to try is Sakagura on East 43rd street, in the basement of an office building. There are several hundred of types of sake to choose from, anywhere from a few dollars to a hundred dollars for a masu (traditional wooden box cup).

May

25

"It turns out that circuit theory shares a surprising number of properties with ecological theory describing animal movements and connectivity," said Brad McRae, NCEAS project leader. "We can now represent landscapes as conductive surfaces — with features like forests and highways having different resistance to movement — and analyze connectivity across them using powerful circuit algorithms. Unlike standard conservation planning tools, these algorithms simultaneously incorporate all possible pathways when predicting how corridors, barriers, and other features affect movement and gene flow over large areas."

May

25

One of the big financial businesses of the 19th century was to buy cheap Latin American sovereign debt, and then enforce payment by use of gunships. Apparently, the system is back, and its opponents too.

The Paris Club of official creditors decided to prevent aggressive investors buying poor countries' debt at a low price and then suing to recover large sums of money. There is growing irritation among international development agencies and NGOs over the actions of "vulture funds", which buy up discounted debt, often of developing countries, and then sue the government for more money than they paid. The emergence of litigation by vulture funds is forcing some poor countries to use spare money to settle debt claims, angering the other creditors who have written off the debt.

A British high court judge ruled in February that Zambia must pay the investment firm Donegal International a much larger sum than the $4million it had paid for the country's debt. The International Monetary Fund, World Bank, and Western creditors wrote off a large part of Zambia's debt in 2006.

I remember reading that among many others, Turkey and Venezuela's debt was recovered by these methods. Theodor Herzl offered to settle Turkey's debts for a charter of South Syria, then a Turkish province.

May

25

Because it is so difficult to reliably estimate potential output using either the aggregate or the growth-accounting approach, it should come as no surprise that we at the Federal Reserve use a lot of judgment in constructing our estimates of potential output. In particular, we see judgment as playing three important roles in our procedures. First, it enables us to take account of the effects of structural changes in the economy that cannot be modeled directly. Second, it allows us to deal with model misspecifications that cannot be corrected. Third, we can use judgment to correct for measurement errors or inconsistencies in economic data. For example, we judgmentally adjust model-based estimates of the NAIRU to account for movements in the unemployment rate unrelated to changes in labor market slack. Of these, the most important has been the shift in the demographic composition of the labor force, driven largely by the entrance and subsequent maturation of the baby-boom generation. But economists have pointed to a number of other factors that would influence the NAIRU as well.

If I may translate, I believe that boils down to “we wing it”. And he candidly shatters a Greenspan myth:

…after employment recovered [in the mid 90s], it became clear that the unusual behavior of employment during that period was explained better as a temporary reluctance by firms to hire than as a step-up in the rate of trend productivity growth.

A standard element of Greenspan hagiography is his epiphany on technological productivity explaining unexpected employment patterns.

Good policymaking requires that we acknowledge what we are unsure about…

Kudos to the candid Fed governor.

May

24

Necessity is the mother of invention. The S&L debacle gave rise to commercial conduit financing for real estate, which in turn was the catalyst for the virtuous cycle of real estate value increases concurrent with new financing options and increased home ownership globally.

The real estate business is now going through a transition phase again, like a snake shedding the skin it has outgrown. The new systems being created are far more robust and inclusive of market segments that were not afforded the opportunity to participate in the most recent virtuous cycle.

The bottom line is that although there are very real concerns about localized markets around the world, the rapidly evolving systems being developed are taking this into account preemptively. The coming changes are not small; they are gargantuan. Stay tuned.

May

24

"Whether people are making financial decisions in the stock market or worrying about terrorism, they are likely to be influenced by what others think. And, according to a new study in this month's Journal of Personality and Social Psychology, published by the American Psychological Association (APA), repeated exposure to one person's viewpoint can have almost as much influence as exposure to shared opinions from multiple people. This finding shows that hearing an opinion multiple times increases the recipient's sense of familiarity and in some cases gives a listener a false sense that an opinion is more widespread then it actually is …"

May

24

It seems candle-charting technique may soon be of little value, if it ever was, due to the advent of electronic markets. I say that as the "seamless" markets we now have are losing a "true opening' as prices close in the pits, then open a few minutes later. Hence, there are no gaps between the close and opens as we once enjoyed.

Since candlesticks operate on the sole basis of the opening and the close, to form the body, the new electronic way of recording price movement totally redefines the spirit as well as the body of candlestick charting.

I guess Nisson, et al, will have to file a habeas corpus with the exchanges or devise some new glitzy charting technique.

David Goodboy writes:

Many intra-day traders use candlestick charting. In fact it's the default style on most software packages. I believe your idea applies to daily candles only, wherein the open and close of an intra-day candle are based on a chosen timeframe and not the exchanges.

Larry Williams replies:

I know many traders use candlesticks, intraday, but there are two problems there.

1) What time period is best in electronic markets where for hours nothing happens and then all four alarms go off? The solution is to not use time-based bars. But then what do the candles mean?

2) More important, when I test candlestick patterns most all of them have no predictive value. The sells are better as buys and the supposed best buy, engulfing bullish, is not even as good as a placebo pattern.

Since putting this view forward in an article in Futures Magazine 16 years ago, I still get the same answers in testing these patterns. They may be a great art form, an adjunct for trading to use in consideration of other factors. But my research does not support using them on their own. I am open-minded to all research of these patterns. There is some literature out there purporting they work. Read and test as I have, however, and I think you would disagree.

Brian J. Haag writes:

What time period is best in electronic markets where for hours nothing happens and then all 4 alarms go off. The solution is to not use time-based bars. But then what do the candles mean?

This has always been true to an extent. Those who only use time-based measures have been at a disadvantage. It's just that now it's getting worse.

May

24

The following song came home in my son's folder yesterday. I thought that I would share. I asked Jacob what the lyrics to the song meant. He replied, "We have the freedom to buy and sell what we want to as long as we have money". Then he asked, "When can I make money?" I said soon enough.

May

24

I find that there is a much wider range of financial books available than a few years ago, when everything was Sage related ('when will this conglomerate reach its appropriate value at book?' etc.).

I recently bought Point and Figure Charting by Thomas Dorsey, which has a million anecdotes about stocks that worked out, with no tests whatsoever, but is suggestive. I also bought The Volatility Course by Geoge Fontanills and Tom Gentile, which has many strategies for staying the course in low and high volatility environments, a discussion of put/call ratios, and much discussion of implied versus historic volatility with the kitchen sink of chart patterns, Bollinger bands, and media to read and watch.

Fat-Tailed and Skewed Asset Return Distributions by Rachev et. al. contains a nice workman-like introduction, at a level just augmenting elementary statistics and statistical methods for understanding volatility. This appears to be a very useful addition to the quantitative traders collection. Also, The Encyclopedia of Trading Strategies, by Katz and McCormick, which I have bought five times already, but regrettably forget that it only covers data through to 1998, and has no awareness of the principle of ever changing cycles. It does however provide a reasonable methodology for finding systems that worked in different environments which could be ready to expose the fixed system trader to losses in future.

I believe that instead of reviewing these next, I'll review the Ring Lardner Reader which has many timeless stories from the 20's and characters that are similar to so many we meet with in trading today.

From Laurence Glazier:

I received a copy of The Volatility Course unexpectedly and enjoyed the read. It is to some extent an advertisement. Not unheard of in trading books. There is a useful table of optionable instruments to use, e.g., easy ways of trading the dogs of the Dow.

As for the basic premise that one should buy low implied volatility, if that were so, one would have to question the judgment of the selling market maker, or is that too simplistic? A better reason for me would be that there is less risk of volatility crush in the low IV purchase.

I like their risk profile charts but they are suggestive of risk from the outset of the trade rather than from the current position, so what appears to be a favorable graph may in truth be shouting, "Take some money off the table".

May

24

1. To what extent is the first tick of the day predictive of the subsequent moves?

2. Are small down moves from the previous close more bullish than small up moves as of any given hour? In other words, do the moves from close tend to oscillate around unchanged to an inordinate extent, and does this relate to whether the next move will be up or down?

3. To what extent are divergences between the NASDAQ, the Dow and the S&P predictive or anything?

4. What is the significance of massive recurring selling in the afternoons, with buying overnight?

5. To what extent is the entire drift in stocks unavailable to day traders because of the necessity of closing out positions, and how does this relate to whether the individual stock has been up or down?

6. What are the times of day when stocks are least/most volatile, i.e. when can a person get a good tennis game or walk around the park in, without worrying about the wolf?

7. Are double or triple tops and bottoms violated to an inordinate degree?

8. After a series of continuations, taking out the reversals between bid and ask, is another continuation more likely than a reversal?

9. After a unchanged open, are reversal strageges better than breakouts?

10. Are there any fixed systems; points, moving average, pivots et. al., that flexible traders can shoot for with a view to relieving the inflexibility of their chips?

May

24

Conclusion: The yield gap - the difference between the stock market earnings yield and the long term bond yield - can be interpreted as a simple measure of the yield spread of stocks versus bonds, or a relative long-term rate of return of stocks against bonds. By using the definition of returns, I derive a dynamic accounting decomposition for the yield gap, where it is positively correlated with future stock market returns and negatively correlated with future dividend to earnings payout ratios, growth rate on future equity earnings and future bond returns….

May

24

NEW YORK (AP) — Stocks wilted Wednesday as comments from former Federal Reserve Chairman Alan Greenspan and worries about upcoming economic data deflated a rally fed by takeover activity.

Those who have been around as long as I have seen these ephemeral events played out many times before after comments were attributed to the hot hand with an esteemed reputation.

There was a time when Dr. Doom Henry Kaufman was known to dramatically impact the markets, especially the bond market, with his interest rate predictions. This was while he was with Salomon Brothers in the 70s and 80s.

There have been others who had limited success with predictions and moving the markets, such as Elaine Garzarelli of Shearson, Abby Joseph Cohen of Goldman, Bob Farrel of Merrill Lynch, Bob Prechter of Elliott Wave, Bill Gross of Pimco, and Joe Granville in the 70s. Even Alan Abelson could comment on a stock in his weekly column for Barron's and have a big effect on its opening on Monday. A comment on a stock in the Heard on the Street column could also be worth a point or two. There have been others over the years.

From John Tierney:

From Stefan Jovanovich:

I believe Mr. Leslie was referring to the total increase in market valuations, not the percentage gains alone. By that standard the late 90s were qualitatively and quantitatively different from the other periods Professor Pennington noted.

The recovery in the ticker from 1932 was hardly viewed by the public as a "rise"; Americans remained hostile or, at best, indifferent to securities investing for another generation. It would be equally hard to see the post-Spanish-American war boomlet as comparable since the U.S. was not yet considered a financial center equal to Berlin, let alone London.

While the 1926-28 Wall Street boom may have outperformed the late 90s by a slight margin, the level of public participation was not comparable. As a percentage of the total adult population, fewer Americans had checking accounts in the 1920s than had securities holdings in the 1990s.

Charles Pennington adds:

It is true that the market went up a lot after December 1996, but I don't see any basis for saying that post-December 1996 was the "greatest rise in the history of the United States."

Why make such sweeping statements without checking them first? It is like saying, "Nobody hit more homeruns than Willie Mays."

Sam Marx adds:

Back in the early 50s or maybe the late 40s, Walter Winchell would end his heavily listened to Sunday program with a stock tip that would create a buying binge for that stock on Monday morning. The Stock's Specialist would open the stock substantially higher and buy back at lower prices as the institutions would come in selling their holdings.

When someone asked Winchell where he kept his money, he quipped, "In rubber bands".

From Sam Marx:

Michael Milkin should be given a pardon.

He created the junk bond market, was influential in financing many of today's largest businesses including CNN, and building the modern Las Vegas. Now he is using his funds for prostate cancer research.

I believe that with all his capital and important character witnesses he could've stalled and defeated the charges against him which were mainly "stock parking" charges. He pleaded guilty to save his brother from going to jail.

He was a threat to some of the moribund corporate boards because he was able to raise the capital, through junk bonds, to enable the takeover artists (Ivan Boesky was not a takeover artist, he was an arbitrager) to gain control of these companies and remove those moribund boards and revitalize those companies. I've heard that the word came from the highest office in the government to get Milken because he was a threat to the entrenched country club set.

Ironically, although he is credited with it, the idea of using junk bonds to take over companies was not Milken's idea. A superior at his firm suggested it to him.

Some such as Ben Stein consider Milken a charlatan. I do not know the exact details of Stein's reasons but I do know that Milken used a Harvard study that showed that a portfolio of high yield bonds would over a period of time outperform higher quality bonds. This may have been valid at first when he was selling existing high yield bonds as a bond salesman but the type of bonds that Milken later created did not fit the properties of the high-yield bonds in the Harvard study.

Before he moved to California, Milken worked in Philadelphia and then N.Y.C. and lived in Cherry Hill N.J., two blocks from my house. When he was commuting to N.Y.C. he would take the bus very early in the morning wearing a coal miner's helmet to read company reports in a dark bus.

May

24

Real time substitutions are taking place in commodities due to NYC Mayor Bloomberg's schedule for all NYC taxis to be hybrids by 2012, and also the increased presence and use of other energy sources such as solar and wind. I wonder about the dire predictions of $100 per barrel oil.

I also heard today the suggestion that if U.S. drivers switched to the equivalent European models, one year's consumption Chinese oil would be saved. I wonder about countries such as Venezuela and Russia, which are heavily oil-dependent and moving in non-market friendly directions.

Henry Gifford replies:

Yes, things are changing a little. Many NYC taxis are already hybrids, the jeep looking ones. As they are driven more than other vehicles, the payback is more attractive, with drivers reporting huge savings, especially when the air conditioning is off. Looked at another way, a non-taxi hybrid sits idle most of 24 hours, yielding no payback.

Yesterday I heard about a New York State agency paying about 2/3 of the purchase cost of a solar system that has a 94-year payback. Solar is nice, but expensive.

Wind in urban areas is mostly for show, as velocities close to the earth's surface are lower than a few dozen meters, and it is hard to harvest energy from the turbulent wind currents near buildings.

This all strikes me as two examples of the government using our money for things that don't pay well. That is unless the systems installed result in property tax increases exceeding the value of the energy saved. This isn't unheard of. It would be one example of the government partly taking credit for a change already in progress, and perhaps slowing the change down in the process, by encouraging taxi owners to wait for the government to set up the plan to pay them for what some are already doing.

May

23

In Models of Adaptive Behavior, Houston and McNamara discuss the state of an organism and how that might affect its behavior. The state is characterized by a set of variables.

An overfed bird is less likely to engage in risk to feed. Its state is overfed and one can predict it will spend less time feeding when hawks are around. Companies like the Sage's are overfed, and by their own admission not feeding. It can't find food because it has no incentive to search when its state is overfed. It doesn't engage in research, as it has plenty of food. It's old, and doesn't seek partners, and won't reproduce. It relies on pecking order and crowing like an old rooster.

A company with no earnings is hungry, lean and will take risks, engage in research, and searches for new niches, new partners. A young company seeks partners and more capital.

Steve Ellison writes:

Geoffrey Moore wrote the book on this topic for the technology sector. It's called "Crossing the Chasm". There is a "chasm" between the needs of early adopters of a new technology product who love new technology for its own sake and the mainstream market of conservative information systems managers who want others to be the guinea pigs for a product before bringing it into their own organizations.

The companies that successfully make the transition from serving the relatively small number of early adopters to gaining significant market share in the mainstream market generally start by customizing their products for a specific niche market. Ideally, customers in the target niche should be currently served only by general-purpose offerings from large companies. By customizing its product, the upstart company can offer a product that is five to 10 times better for the target niche. Thus the company can dominate the niche, while staying under the radar of the large companies, who perceive only scattered customer defections. The niche gives the company a highly profitable customer base from which it can expand to a larger market.

Here is an example of how I might use Mr. Moore's ideas. Looking at this week's Value Line, I see five stocks with Timeliness ranks of one or two in a technology-related industry. I instantly recognize company A as the leading company in the industry with a larger market capitalization than all the others combined. I research the other four companies. I find that company E operates exclusively in a niche within the industry. In this niche, company E has the leading market share, 30%, well ahead of company A's 18% share in this niche. Thus company E appears to be a potential chasm-crosser, a potential high grower for years to come. Companies B, C, and D each operate in one or more niches, but none is a niche market leader, so I am not as interested in them.

May

23

The latest report from Amnesty International (see the FT report below) provides more grist for my foot-shot theory of human affairs. Can anyone ever make a profit without it being 'exploitiation'?

I thought I'd try to learn more about the field of economic inequality and discovered that Amnesty International evidently subscribes to the 'dependency theory'. But there are three other major types of theory about variations in nations' wealth, plus Richard Lynn's deeply unpopular thesis, which claims it has more to do with national IQs than anything else:

1) Dependency theory: Proposes that the economically developed capitalist nations are responsible for the poverty of the underdeveloped nations because they dominate the world economy, force the rest of the world into economic dependency, and pay low prices for Third World agricultural products and natural resources. This is why we get products labeled 'fair trade' in supermarkets.

2) Climatic theories: These propose that different climates naturally lend themselves to different levels of economic activity.

3) Neoliberal theory: Proposes that the major factor responsible for national differences in economic development is the presence of free markets as opposed to command, socialist, and communist economies.

4) Various psychological theories about motivational factors, such as the Protestant work ethic, have helped northern Europe.

Perhaps several of these theories have an element of truth, but I do find Lynn's hypothesis quite compelling, especially if his IQ/GDP correlation (0.82) is correct. And I can see why it might be rejected without study.

Given the taboo surrounding Lynn's ideas, could they be used for investment purposes? Well maybe. Just go long on a high IQ country that has been held back for reasons that are being reversed. Conversely one might short the hell out of a wealthy country in which the average IQ takes a sudden nosedive.

I started wondering about how someone should set about investing in Mongolia. To my dismay, I discovered that Lynn had already investigated the IQs of Mongolian kids and found them to be 5 lower than Han Chinese living in the same community. I guess it's back to the drawing board.

So it looks like genes are not enough, IQ is probably dependent on factors other than genetic material alone. But perhaps there's still an angle here for investment in companies.

Now I've seen lots of theories about how buying into companies with a good ethic works well (without quantification), but nothing based on IQ. And there are a couple of companies I can think of whose ethics have been criticized but not the brains of their leadership; Google and Microsoft.

Could there be a bias against brains that might be profitably exploited? I suspect that most people would much prefer to invest in dull honesty rather than the too clever by half. But maybe they are wrong.

From the FT's website:

The United Nations must develop international standards that hold big business accountable for its impact on human rights, Amnesty International says in its annual report published on Wednesday.

There is evidence in many parts of the world that people are being tipped into poverty and trapped there by corrupt governments and greedy businesses, Irene Khan, Amnestys secretary general, says in her foreword to the report.

According to Ms. Khan, a growing demand for mining, urban development and tourism projects is putting pressure on land, across Africa, Asia, and Latin America, with entire communities evicted from their homes without compensation or alternative shelter.

She says that weak, impoverished, and often profoundly corrupt states have created a power vacuum into which corporations and the economic actors are moving.

In some of the most resource-rich countries with the poorest populations, big business has used its unbridled power to gain concessions from governments that deprive local people of the benefits of the resources, destroy their livelihoods, displace them from their homes and expose them to environmental degradation.

Africa has long been a victim of the greed of western governments and companies, says Ms Khan, but she singles out China and Chinese businesses for showing little regard for human rights on the continent.

May

23

How strange it is that a bird, under the form of a woodpecker, should prey on insects on the ground; that upland geese which rarely or never swim, should possess webbed feet; that a thrush-like bird should dive and feed on sub-aquatic insects; and that a petrel should have the habits and structure fitting it for the life of an auk! and so in endless other cases. But on the view of each species constantly trying to increase in member, with natural selection always ready to adapt the slowly varying descendants of each to any unoccupied or ill-occupied place in nature, these facts cease to be strange, or might even have been anticipated. — Charles Darwin in Origin of Species

This quote can be used to give insight into which managers and companies should prosper in the future. What is their niche? How do they protect themselves from competition? What is their function in the feeding web — the web that enables the vast infrastructure of costs to be absorbed, and the strong players at the top to make their billions at the expense of the public? How can they exclude competition in the future, and what specialized structures do they have to do their job better than others?

If none of these answers are positive the company or manager will be subject even more than most to the laws of ever changing cycles.

The subject of niche theory is nicely covered in this article from the University of Georgia, and has wide applications to the day and the fray in markets.

May

23

I attended a presentation by Andrew Lo on 'The Psychology of Trading,' on May 21 2007. Here is a brief summary of his remarks:

On the one hand the Efficient Markets Hypothesis is at the foundation of Finance (for example all the work by Black-Scholes assumes that the market for options is efficient) on the other hand many people nowadays find it hard to believe that EMH is literally true. This has led to the development of Behavioral Finance, which studies biases that may hinder financial decision making. BF has acceptance problems of its own: it brings up so many possible biases that it is hard to believe (if all these biases are true) that anyone is ever able to make a correct decision. Many economists ask if the behavioral biases even exist.

To try to advance beyond the EMH/BF debate, Andrew Lo has been working on his own framework, which he calls the Adaptive Market Hypothesis, and has been investigating the role of emotion in trading by reading the neuropsycholgy literature and conducting experiments, some of which will be described below.

Do perceptual biases really exist

The first experiment involved the audience. They were invited to watch a video showing college students, some in white T shirts and some in black T-shirts throwing basketballs to each other. Lo told the audience to concentrate on the white T-shirt players and count the number of times they passed the ball to each other. The exercise was made more difficult by the fact that the black-T shirt players intermingle with the white shirt players and that Lo kept talking throughout the video to try to confuse the audience.
After the video was over Lo asked "how many people saw the gorilla?". More than half the people in the audience had not seen any gorilla. [I personally did not see the gorilla, even though I knew that Andy Lo is famous at MIT for showing a video in which a gorilla appears !]. Lo replayed the tape, and sure enough a man dressed as a black gorilla walks through the scene halfway into the tape. Lo explained that people who are concentrating on white figures will often miss black objects; in some sense the human perceptual system is filtering out the black objects.

In conclusion, said Lo, in any debate between economists and psychologists as to whether perceptual biases really exist is going to be won by the psychologists, who have demonstrated these phenomena beyond doubt through careful experiments.

The neuropsychology literature

The book "Descartes Error" by A. Damasio has changed how we view rationality. The classical philosophers believed emotion and rationality were polar opposites. Damasio investigated people who have suffered serious brain injuries and found that people who do not perceive emotions correctly will act irrationally. Emotion is necessary for rational behavior, Damasio says. Emotions allow you to choose quickly and easily among the many choices constantly available to you, saving you time and allowing you to zero in on correct solutions to problems.

The Triune Model of the Brain was proposed by Paul McLean. The human brain is made up of three parts: -the brain stem, which controls basic functions such as breathing and wakefulness is the oldest part of the brain, philogenically speaking. It exists in reptiles as well as in higher life forms. -the midbrain is involved in emotions (such as fear and greed, sexual preference and so on). It exists in mammals. -the neocortex controls higher functions, is the seat of thinking, language, etc. and exists only in hominids. There is a definite order of priority among these three subsystems; a painful stimulus for example will disrupt the processing functions of the neocortex for several hours according to experiments in which blood flow to the brain is measured via MRI scans. When a lower level is activated it disrupts (or takes priority over) the higher level mental functions.

From a financial point of view it is clear that risk-preferences and decisions under risk arise from interactions between the midbrain and the neocortex. Rational decision involves a balance and/or cooperation between the emotional and calculating parts of the brain.

Experiments in neuropsychology and finance

(1) Studying professional traders as they go about their job. Lo attached sensors to traders to measure emotional responses. (2) Lo also interviewed 80 neophyte traders who were learning to trade in a class given by LBR and reviewed their trading

Conclusions

a. emotion is definitely involved in trading decision making, even in the case of experienced decision makers (i.e. it is not solely the beginners who experience these emotions). However, the emotions are somewhat more controlled among the more experienced or more able decision makers. b. traders who experience little emotion during trading have a lower P&L, however traders who experience a great deal of emotion during trading also have a lower P&L. It appears that there is an optimum level of emotion somewhere in the middle. c. people who excessively internalize the outcomes (i.e. attribute everything that happens to their own doing) have a lower P&L, however people who attribute everything to luck also have a lower P&L. Again there appears to be a proper balance, i.e an attitude that events are partly due to ability and partly to luck.

The Adaptive Markets Hypothesis

The AMH takes a biological/evolutionary view of markets, whereas the EMH took a physical/engineering view.

With regard to point 3. Lo has a high regard for Herbert Simon and his idea of "safisficing" (not optimizing), and of making decisions through simplified (and non-optimal) heuristics (since an optimal decision is computationally infeasible). A question that Simon could never answer is "where do heuristics come from", but Lo thinks the answer is that "evolution determines heuristics" (point 5). He did have not elaborate on this. Lo expressed the view that Simon's work is even more important than the Theory of Rational Expectations, even though it has received less attention in economics.

The AMH implies that anomalies can appear, disappear and then reappear again as the market ecology changes. For example the profits to Statarb have waxed and waned over the last 15 years. It is true that the profits have dropped sharply after the Summer of 2002, but this does not mean that hey have been permanently arbitraged away. Statarb profits may not be gone forever, they may come back at some time under different market conditions than what we have now.

So far the AMH is incomplete. Lo is working on extending it and convincing others.

MAIN CONCLUSION

We need emotions to be rational. We need both, it is not either/or. In trading there is a right level of emotion. There is a "right zone". The Zen of Trading.

Jean Paul Schmetz writes:

It is almost impossible to see the gorilla [see video] if you concentrate on the players. I have tried this video with 100+ people in the room and very rarely did more than 10% see it. It usually helps to mention beforehand that males or females are better than the other at keeping score (you do not tell which and so people concentrate even more).

Chris Hammond adds:

There is an article in Scientific American this month that discusses a game called the "Trader's Dilemma," which is a variant of an older game called "Prisoner's Dilemma." Experiments involving this game address some of the issues mentioned earlier. There is, of course, some extraneous background story, but essentially, the game works as follows: two people pick a dollar amount between 2 and 100. The smaller of these two amounts will be awarded to both players, except the person who chooses the smaller amount will receive an additional $2 and the person who chooses the larger amount will receive $2 less than the lower of the two amounts.

If the players pick the same amount, then there is no penalty or reward. If you assume that both players are working solely for their own self-interest and make rational decisions, then both will pick $2. However, in an experiment where the range was between 80 and 200 cents, and the penalty/reward varied between 5 and 80 cents, the player's average choice was never the Nash equilibrium of 80 cents. For the 5-cent penalty, it was 180, and when the penalty was 20 cents, it was 120. This particular study used economics students. A similar study used game theorists, and the results were similar.

More interesting is what happens when people play the game repeatedly. Apparently, for "large" rewards, the amount that is picked as people play many times tends towards the low number, 80. For "small" rewards, the amount moved towards the high, 200. The article is not more specific than that.

Here, a system evolves as participants learn. It's also interesting that there is a bifurcation at some particular reward amount, and that the system evolves completely differently on either side of that value. Also worth noting is that not even game theorists think like game theorists.

Yishen Kuik writes:

I have been reading E.O. Wilson's Consilience, which has a nice chapter on what we know about the brain.

He also has a good chapter on what it takes to be a productive scientist engaged in the business of discovery, some of which seemed to me to be uncannily applicable to describing the business of uncovering statistical edges to trading.

May

22

For the last week I've been using public transportation. It is an interesting slowdown in life. You are forced to sit back, wait for buses, trains, and ferries to come. They then slowly meander around the loops and turns until they get you to your destination.

It's made me think that at times you may need to move from equity index trading to short-term rates in order to slow down and smell the roses. With less volatility, more windows to gaze out of, and interaction with a higher proportion of the general population, I achieve a broader viewpoint.

May

22

From the Financial Times’s site. I do wonder about the name “rat investors,” given the high regard in which rats are held. Is it a compliment?

Chinas Day-Traders Look for Black Horses, By Geoff Dyer in Shanghai

Published: May 22 2007

The thousands of ordinary Chinese who are signing up each day to trade shares are not too concerned about the conventional ways of valuing a stock, but they need to know the difference between a ghost and a black horse.

Chinese have combined a traditional delight in word-play with their new-found passion for stocks to create a rich supply of colloquial jargon for investing that is bandied around brokerage offices.

Ghost shares are highly risky, but black horses have beaten expectations. Buying cheap to sell high later is known as fighting for the hat, while selling at a loss to avoid further losses is meat slicing. Investors who think a piece of news will boost prices claim to be lifting the sedan chair.

When a fund manager was sacked last week for allegedly manipulating share prices, websites hummed with talk of rat investors, the term for insider traders.

There is even a Chinese phrase that could define the current boom. On top of bulls and bears there is the deer market, when large groups of amateur, short-term speculators cause markets to move in erratic jolts.

May

22

Few college students pay full freight. Most get a package of grants, scholarships, loans, jobs, etc, designed to allow them to pay according to their ability to pay. It's an ingenious method to milk the most and get the highest price.

However, at under $20,000, it's still a great deal. Education in America is the dividing line between the classes, and the key to upward mobility for most.

May

22

The following interview with Yvon Chouinard, the CEO of Patagonia, was sent to me yesterday. I feel that a lot of the points made and discussed are amongst the principles that have been discussed on this forum. Some of the highlights and quotes are as follows:

"I don't have much faith in that the government is going to do anything, but I can tell you that there is a revolution in business going on right now. And it's only been going on for the last two years, maybe the last year or six months."

"Yeah, well I used to hop freights when I was in high school a lot. I'd go up and down from L.A. to San Francisco. Once I was hitchhiking across the country and hopped a freight and got caught by some railroad bulls. I was thrown in jail for 18 days in Winslow, Arizona."

"What some people consider risk, I don't consider risk. I've been a mountain climber all of my life. I do a lot of risk-type sports: whitewater kayaking, surfing and things like that. I don't think there is risk whatsoever if you've done your homework. That's the whole thing. It's managed risk. I love living on the edge in some of these sports, but I never go over the edge. I think the biggest risk is just to be stupid, to not do your homework. That's where I see a lot of businesses go under."

"And I think these days, a lot of kids are trying to live their lives out through celebrities. They have no confidence. They have to buy the same surfboard that the world champion rides because they don't have any confidence that they'll be able to ride any other board. Or they have to have the same tennis racket that Roddick uses. I think having the confidence that you can change things makes you an effective leader."

When having everyone in his shop read a book on "peak oil," he wonderfully evoked and used the "Law of Ever Changing" and realized that Patagonia makes a lot of winter or cold weather clothes. So they started to get into the surf business because "the waves are only going to get bigger, the storms are going to get bigger and people are going to go to tropical areas."

While I don't believe that we are in environmental crisis, I do feel that awareness, respect, and preservation are important. We are gradually adapting to this and finding ways to profit as companies, and this is awesome. I was raised to always walk out of a room and have it in better shape than when I went in. The Navy was the same way to me. And the outdoors, while implementing a "no trace left behind policy," is very similar.

The part he mentions as a revolution having recently been started certainly seems to be true. It's nice to see free markets and capitalism do their thing and profit during this process almost as if it was in perfect harmony.

Now one thing I'd like to mention to Mr. Chouinard is if he feels that all young kids do is "watch TV, play Gameboys, and sit on their butts," then he better be picking them up. They are the ones that'll be buying his clothes!

May

22

Foregoing the goal of finding the 'best' model, we propose an exploratory, model-free approach in trying to understand this difficult type of data [financial returns]. In particular, we propose to transform the problem into a more manageable setting such as the setting of linearity.

May

22

The main usefulness of the Fed model is to identify risks in the bond market. Specifically when stock yields are low but the Fed model gives a "buy signal" anyway, it is evidence that bond yields are unusually depressed. That signal is typically followed by poor bond market performance (with no reliable implication for stocks). [More from Hussman]

Victor Niederhoffer adds:

In one sense, it is good to see such information disseminated , in that it's so wrong. Still, it is unfortunate to see because the public might believe such a conclusion and lose so much more than they should.

Jeff Sasmor adds:

If you look at this Hussman performance chart you'll see it doesn't show great performance. Reading his commentaries from time to time he reminds me of the permabear in Barron's weekly column.

May

22

Yesterday was almost an all time (close) high for the S&P 500. Will it actually happen today?

The last high was 3/27/00, about two above yesterday's close, and 1797 trading days ago. How does this compare with other wait times between new highs in the S&P 500 since January 1959 (prior all-time high considered that of February 1950)?

It turns out that the current wait is the second longest of the series; 100 shorter than the 1897-day wait which was broken on 7/17/80, but far longer than the third place wait of 819 days which ended on 3/16/72.

Here is stem-leaf of waits:

Stem-and-leaf of gap N = 776
Leaf Unit = 10

(2nd column is hundreds, 3rd column is 10s)

The arrowed row will be the end of the current wait, should that occur tomorrow or Wednesday.

May

22

During a recent discussion with a friend we competed to pick an all-time basketball team.

I went first, which you would think would give me an advantage, but I soon found out that this was not the case, as he picked a team that would match up quite nicely against mine and exploit their weaknesses.

My friend was quite confident that his big men would more than handle what is really a small line up. He was quite confident that Wilt would have no trouble handling Shaq. Although we both felt Shaq had the "mass" to have a slight physical edge on Wilt, we also both agreed that Wilt was a much better athlete than Shaq. Edge to Wilt.

Although you'd rarely see these two team up against each other in real life, since Duncan is more a center than 4 forward and Malone is more of a 3 forward than a 4 forward, my friend grudgingly gave me the edge with the Mail Man (Malone) since he had what may have been one of the best fade-away jumpers in history and was known for tenacious defense. Duncan has a decided height advantage and is no stranger to trading elbows, but still the slight edge had to go to Malone

Bird vs. Hakeem. Both players were known for their tenacious defense and neither player shied away from banging under the boards. But again, we had an odd match up. Hakeem was definitely more of a 4 forward and Bird was more of a 'tweener, in between a 2 guard and 3 forward. We gave Hakeem a slight advantage on the inside (only slight, mind you), but because Bird had such a demonstrable difference in his outside shooting and overall passing ability we had to give the advantage to Bird.

My friend felt that I had such a huge advantage in my guards that he had to get creative with his choices. His goal was to exploit the size and physicality advantage his team possessed by bringing a great shooter to spread the floor. But at the same time he wanted a guy who could drive the lane and pass with the best of them, while also playing tenacious defense, thus his choice of Pistol Pete.

Now, neither of us was under illusions that Jordan wasn't the better player. He was the entire package, the kind of guy you build a franchise around. But Pistol Pete would have kept Jordan honest. Maravich was one of the smartest and most intuitive players on the floor. Jordan would have had to move out of his role as key scorer into one concentrating on assists and opening up the floor for his shots. Edge to Jordan.

The 1 guard was the position that caused my friend the most trouble in matching up against my team. Magic Johnson was the consummate player, capable of playing and dominating any position. So Steve decided that he would simply slow Magic down with one of the greatest defensive floor generals in the game, John Stockton. And since he had such a powerfully dominant big man, he didn't need a scorer. He needed a passer.

Stockton was the best floor general ever to play the game (in my humble opinion). That is what he would exploit in Johnson. His tenacious defense would slow Magic down and his passing ability would keep Magic honest. And on top of that, Stockton just so happened to be a very good shot. Still, we both agreed that Johnson would have a slight edge.

There were a myriad of other players that we talked about including in our line-ups. Oscar Robertson, Jerry West, Kareem, George Gervin, just to name a few.

Interestingly, even though my team had a slight advantage in the individual match ups, neither of us could decide which team would win more games.

May

21

For the vast majority of people, the best thing to do is concentrate on their personal residence when it comes to real estate. Building a portfolio of real estate can be an extremely complex venture, as there are many moving parts to the process.

There are so many variables that come into play. These include location, negotiation skills, liquidity, devotion of management, time commitment, closing costs, insurance, taxes, repairs, etc. Most people would be better served if they focused on their personal residence and looked to maximize the profit through this venue.

If one wants to become successful in investing in real estate, one needs to be very knowledgeable about mortgages. Not just conventional mortgages but interest only, balloons, ARMS, and some other esoteric mortgages that all can be used depending on the needs and wishes of the investor. Rates and points also factor into the equation, as do credit ratings, down payments, etc. Thus, this is not a market that lends itself well to the neophyte.

And nefarious and ill-informed mortgage brokers abound. In my view, the barriers to entry in the mortgage broker business are few. It is easier to become a mortgage broker than a massage therapist. So finding a qualified mortgage banker or broker can make all the difference in the world. I have found that similar to the bond market, where the really big money likes to play.

One of the great plusses of real estate is that it is the only investment that one can make and live in it at the same time. Also, you can watch it on a daily basis.

If one wants to play the real estate market, one can use such vehicles as ETF's, REIT's, and stocks of mortgage companies and builders. Subcategories include aftermarket stocks such as Home Depot and Lowe's. Further down the line there are subgroups such as cement, wiring, and plumbing construction equipment like Cat and Gradall.

Before considering purchasing residential real estate, I suggest an intensive study of the industry and the markets that one wants to be involved in. All real estate is regional. Commercial property can become even more complex. Once again, in my view, caveat emptor.

May

21

When you feel the market has been nasty to you, probably one of the best things to do is to invite a good friend over, to open a bottle of wine, and just spend some time together. As a suggestion, I propose a wine which is getting more and more popular in Italy, called Aglianico del Vulture. It is a red wine produced in Basilicata (Vulture area), and it is considered one of the finest wines that is produced in Italy from Aglianico grapes. The color of the Aglianico wine is ruby garnet red with a dry and savory taste, and 11.5-13 % Alcohol. The wine goes very well with meats, especially roasts and wild game.

My approach to the market lately has been quite poor, because of a lack of discipline. I did not close a losing position, hoping that the usual random movement could help me as it normally does (99.5% of the time at least). But the market has not been "normal", and unfortunately this time it worked differently and I could not (or did not want to) find a decent exit. This is a lesson that I am sure will drive my trading behavior in the future.

Flexibility and recognizing your own mistakes is very important. The market has changed behavior in the past 3 months and I have not been able to understand it in a timely manner and act accordingly. Last night I invited a friend of mine over, and spent some time talking about the next holidays, past common experiences, and we enjoyed a couple of glasses of good wine.

Today, my trading loss is still there, but the Aglianico and the friendship worked well. I look to my future trades with more optimism, and with the aim to improve as a trader applying the lesson learned.

Janice Dorn writes:

It is not the markets that one tries to understand, rather one's response or reaction to what the markets are saying. It is a form of inability to take personal responsibility that causes us to lay the blame for underperformance on something outside of ourselves. There is no shortage of people, places, or things to blame. Instead, we may be better served to drive all blames into ourselves and to respond to that activity with self-compassion and learning.

In the end, it is not the markets that have been nasty to you; rather it is you who has been nasty to yourself in the environment of the markets. Friends and wine may certainly help, although I am not completely certain how this works except as a temporary respite

May

21

While the skeptical environmentalist Dr. Lomborg may contest trends in global warming and the increased frequency of natural disasters, I focussed on severe weather conditions in the US between 1955 and 2005. More specifically, having analyzed the annual frequency of hails and tornadoes in both Midwestern states and the whole US, I have come to the following conclusions:

(1) Both hail and tornado observations (not accounting for the severity or resulting economic costs) have risen since 1955. While the tornado frequency increased in linear fashion, hail observations however have grown exponentially over the same sample period.

(2) As one would expect, hail and tornado frequencies are co-integrated, whereby the latter are Granger-caused by the former.

(3) Rates of annual increases of both time series observations are slightly lower for the Midwest than the US on average.

However, my hypothesis that increasing numbers of hail and/or tornado observations might impact US grain markets was not confirmed. Having calculated annual volatilities (on a calendar rather than production year basis) for hard red spring and winter wheat varieties for Midwestern states of production, wheat volatilities were not correlated with either hail or tornadoes observations and consequently no regression yielded any significance.

May

21

"German Finance Minister Peer Steinbrueck will try to win support for closer hedge-fund scrutiny at this weekends G8 meeting. However, Germany's task will be complicated by U.S. Treasury Secretary Henry Paulson's decision to stay away from the gathering to prepare for meetings with Chinese officials next week."

And the best part:

"The U.S. and the U.K. disagree, arguing that markets are better placed than governments to keep an eye on the pools of capital."

Now that's a nice slap in the face! Are the Germans totally naive or did they really think they could take some lead in this topic, especially with the ex-CEO of the world's largest bank turned hedge fund and the representative of Europe's largest financial centre?

An independent research house recently commented: It's a bit like being stuck in the corner of a Hollywood party. You're busting to say something, but Tom Cruise, Angelina Jolie, and Scarlett Johansson keep turning their backs. And Hank Paulson, Ben Bernanke, and Alan Greenspan have already cornered the canapés and are on the other side of the room, laughing and joking with Zhou Xiaochuan and Jin Renqing of China, and Japans Koji Omi and Toshihiko Fukui, Asia's key Finance Ministers and Central Bankers.

May

21

Volatility is an unnatural instrument to trade. It moves up as the market moves down and it spends more time down than it does up. Volatility has a way of making its own time. There can be different measures of time but the calendar method is the accepted method (and only tradable one).

The other method of time that matters is the market tempo (as by John Boyd). The tempo may be sending the message to traders how willing other traders are to add to their positions. The tempo also changes with the players involved. And as the markets are experiencing low public participation, the volatility and tempo may continue to remain low.

May

20

It is nice to see that the Orwellian nightmare that is today's Britain is being recognized worldwide. The big issue in UK politics right now is trash, in particular the move towards a bi-weekly collection of our garbage for 'green' reasons of course. To give you an idea of what it's like here, there are stations not just for bottles, but also for bottles with different colored glass.

But don't laugh too much. I figure it's probably a question of time before the UK's world leadership in these matters catches on elsewhere. Western civilization is getting bored, so what better than to sort through different colored bottle, etc, in the interest of planetary salvation?

May

20

I am back from my adventure where I learned to kayak on the glacial lakes way up in southeast Alaska. The state is three times the size of ginormous Texas. (That is a favored neologism, bigger than gigantic and enormous.)

To kayak without personal horrors of drowning and overturning in the glacial runoff from Margerie or Pacific Glaciers, or higher north on the southeast Alaskan topography, meant cunningly separating a man from his wife, an intrepid sport who wanted to kayak on her own. So I sat in the front and navigated the teal-blue craft through the mirror-calm waters where every 40 meters or so we would spot the distinctive blow-breath of a humpback in the distance, or the right up-close adorable schnozz of a harbor seal, curious about these interlopers in his private preserve.

Though my partner was a long drink of water, standing some 6'4", somehow he managed to fit into the hole in the back and managed to use the paddle with dexterity, even though he had had some sort of rod implanted in his leg from an injury years ago. Stephen was pleasant to kayak with despite his proclivity to steer directly at any other craft within eyeshot. He thought it funny to threaten the peaceful paddling of his wife or strangers. I had to scramble to avoid hitting more than one of these hapless gliding innocents. He thought it amusing to tell people to look at us rather than the bears on the shore so he got all the good pictures. Still, with Stephen in the rear I was not afraid of capsizing, falling out, or drowning.

And now, the secret of kayaking: The hardest part (if the weather is mild, and the water is not turbulent) is getting in or out of the stubborn thing. Once in, you're good to go, and the serenity and Zen of the sport is healing balm. But keep a buddy on land to help you alight. Or keep your upper body strength at max to lift yourself from that devil well where your legs lie forgotten for several hours at a time.

We observed much natural wildlife — black and brown bears, humpback whales, sea otters, dolphins, seals, sea lions, bald eagles, owls, warblers, wrens, finches, geese, moose, and so on. The scenery was elegiac, similar to but different from the glorious scenery I doted on in Antarctica. The towns I visited had manageable populations –3,000, 12,000, 9,000, or the biggest, 30,000 people. These are quaint and colorful fishing villages, people size, and the lore of the fishermen was fascinating to me, as I worked for many years as a staffer on a hunting and fishing magazine. I spoke with men and their families who fished salmon, halibut, and pollock, those tasty fish that go for huge numbers nowadays. A good-sized halibut, for instance, sells for $4-6 a pound, and a single fish, halibut, can bring in $400 or more!

Many of the fishermen of some decades ago became millionaires. Their homes up there, among the firs and the pines stuck so far north in the winter-frigid zones (it gets to -40 an -50 degrees in the 'cold' months), are amazing to see. Life in these villages is quite expensive with rents not too far different from those in big cities down in the Lower 48. I must have brought the good weather as the sun shone much of the time and temperatures wavered between 35 and 55 Fahrenheit. It rained a good bit but I had the right gear to laugh at that minor inconvenience.

The fishermen go out to sea in their sturdy fishing vessels, with winches and hawsers and nets, staying out for 4-5 days, bringing in their huge catches to offload before the fish go bad. Sometimes company boats go out to meet them so they can bring the haul faster to market.

We enjoyed king crab, but even up there, so much work to eat. I am all about sustainable development, meaning that the hunter and fisher must be responsible with their practices and not over-fish and over-hunt. The sea otter, with its luxuriously silky, millipore fur was almost hunted to extinction by the Russians 150 years ago. They are experiencing a bounce-back now, but it has taken many years to recover.

Likewise, the fish we love to chow down on is caught responsibly with only so many pounds of catch permitted and many laws on the books about permitting escapement for the fry. So thoughtless over-fishing does not destroy the populations.

I mentioned pollock, earlier. The secret to 'fake' crab and shrimp in all the supermarkets is pollock, stamped out and plugged and tinted and colored and sold for those who cannot afford the real thing.

When I was a child in England fish was cheap and not many people seemed to eat very much. My mother baked and cooked it all the time, though back then it was not our favorite. She knew even then how healthy it was. And even though we preferred chicken or beef or turkey, it was in its way lighter and more delicious than we gave it credit for.

Did I have any shrimp in Alaska? Because shrimp (prawns) are not captured with responsible techniques, but by dragging the bottom, harming the beds of many fish and their fry, the careful fishermen in Alaska do not go for shrimp, and conscientious expeditions will not serve them.

Nor, for that matter, will they serve farmed salmon, whose flesh is mushy and not as vibrant and tasty as fish from the wild. The honest fishermen of the north disapprove of the limited allures of farmed fish in general. Their craft has been an honest living for millennia and they don't support the elimination of the wild in their wilderness diet.

Well, there. I have told you far more than you cared to learn, right?

My new job is a short bike or even walk to work, a great savings in time and commutation treasure. It's a good company and a solid opportunity. But all in all, I wonder if I would in the end prefer the more stripped-down, beatific, water-pendant life in quaint Ketchikan or St. Petersburg, where the populations are smaller than that in my Upper West Side condo.

Kathryn Lang writes:

I paid for my last two years of school by working a fishing tender out of Ketchikan. I was hired as cook until I burned the captain's toast a few too many times and got a promotion to the deck. I've often argued that the tenders worked twice as hard as the fishing boats. They would fish all day, unload for a couple hours at night, and then sleep.

We would work all night unloading dozens of boats then spend the daylight hours running back to town, unloading, washing up, and then running back out to meet the boats again as the sun went down. You don't know what tired is till you do that for 168 hrs straight. Sleep deprivation is legitimately a form of torture. I became master of the 20-minute power nap, an invaluable skill for a colicky baby 10+ yrs later. Stories from those two summers have landed me several jobs and even a few dates.

Although the riches had slowed by the time I was there, stories of the 3-day $100k fishing hauls were still circulating. Even in flusher times though, it was too hard and too dangerous to allow weaker bodies to stay on board. Fishing is a true meritocracy - something the readers here should appreciate. Careless & lazy people go broke, sink their boats, injure crew, or drown. Other lessons from those summers: I could out-work and out-perform all my male peers, and education doesn't always come with a diploma. Some of the most fascinating, charming gentlemen I've met never stepped foot in high school.

May

20

FX trading has become huge and very popular with the public, system sellers, and brokers. This report is from a dear friend.

I recently spoke to one of the largest Forex FCM's in the country, who has thousands of clients. He made a statement to me that is very telling. Out of the thousands of clients who have accounts with them, only about 60 - 80 are profitable this year so far. A majority are down significantly.

From Riz Din:

Welcome to my world. FX does not afford sufficient protection to the public, and unscrupulous brokers abound. I hear complaints of trading platforms freezing up around the big numbers (payrolls etc), of orders being slipped, and of stops not being honored. I will not question the validity of these complaints but I do not believe they lie at the heart of the problem. Instead, I attribute most retail level blow-ups to inadequate capital and excessive leverage — with just 10k the inexperienced retail investor can command up to 4m of underlying.

There is also a high level of price uncertainty due to the lack of an underlying marketplace (this is being addressed). Also, while the manipulative marketing by brokers and system sellers is worrying, I have faith in the development of the market over the long-term. Spreads have tightened considerably over the past five years, and banks are moving into the retail space, offering trading platforms with more credibility than the off-shore broker who sends marketing e-mails offering 'price guarantees,' 'no slippage,' etc.

Also, while this may be less relevant to the day trader, another factor that makes FX trading a tricky proposition is the absence of a clear upward drift. Individual exchange rates may appear to exhibit long-term trends. But at their core, we are just dealing in relative prices and there is no such thing as a built-in reward for the entrepreneur such as is found in the equity market. Banks are now launching various ETF-type products that claim to capture the exchange rate beta — incorporating strategies that have proved rewarding over the longer-term, such as the carry trade. But I believe this is far more questionable than equity beta.

I find the dynamics of this marketplace fascinating, but there is no doubt that it's a tough racket. Still, I am surprised by those numbers.

From Chris Cooper:

I, too, have been trading a lot of forex recently. I don't find it too hard to believe that there are very few profitable retail traders. Most retail brokers run operations designed to milk money from their customers. That, plus the leverage available, pretty much guarantees that few will profit. My commissions are not high, but since I trade fairly frequently (not scalping) I know that commissions alone cost me 50% of my equity annually. Slippage is even more costly. That's a pretty big nut to overcome.

There are retail brokers who are built with ECN technology, and these tend to give their customers a better deal. I would recommend either Interactive Brokers or EFX Group.

Once you move past the retail stage, I have noticed that another serious issue is liquidity. Because of the lack of a central exchange, you end up having to execute in multiple locations to find liquidity and that complicates the trading. Claims about forex being the biggest market in the world (trillions!) are so much hogwash. I can see that my trades have a brief but visible effect on the market occasionally, more than I see by trading index futures. It doesn't take much to buy the entire amount offered at the best ask.

I am optimistic about the industry, and one of the reasons is the big increase in numbers of small retail traders. They are certainly losing more than they have a right to lose, but the competition engendered for their accounts will ultimately better the experience for all customers.

Alan Millhone writes:

You all talk of 'slippage', lack of liquidity, costly commissions, retail brokers who milk their customers. Do all of you stay in the market as a challenge, make a living, just something to do to pass time?

In construction we also have 'fly by nights' who prey on the elderly and the unsuspecting and give the good builders a bad rap. Perhaps it is the same in any business. I have had plenty of experiences in the construction business where on the other end some people run out of money and simply will not pay you. Because the court always assumes the builder is making a fortune, 99% of the time it rules against the builder.

Chris Cooper replies:

To be fair, one must distinguish between the costs of doing business, which are simply features of the marketplace, and those which are borderline fraudulent.

Commissions, slippage, and lack of liquidity are all costs of trading which are fair in principle, and the magnitude is determined ultimately by competition among providers. Also, brokers in the forex markets artificially widen the spreads and take the difference for themselves, and trade against their customers. While perhaps not unethical, such practices don't enhance the perception of fairness that will ultimately lead to increased participation. Traders can educate themselves to avoid these brokers, but for now plenty do not.

From Yishen Kuik:

This brings to mind epidemic models. If account fatality rates are so high, should one assume that marketing is a key driver in this business (to renew the population of accounts)?

Vincent Andres adds:

My experience in the market is short. For what I understand from this retail market, I don't see that brokers need to do great marketing. In fact FX customers are too optimistic. They see what they want to see, e.g., "Mr. X won the FX contest with 1000%." They don't see what they should see, that 99% of participants loose their account.

I posit that some of the overconfidence may be due to the presumed knowledge each of us has about currencies, which seems simply better than what we have about stocks, etc. I believe I understand the Euro better than Merck & Co./Soybeans etc, simply because I practice/use/own them everyday.

The FX market is a closed finite market, with ten main currencies, 10×10 main vehicles. This may calm people, the liquidity meme, forgetting to look at the granularity of this liquidity. FX is de facto an oligopoly archetype, the guru. I understand nothing. But I rely on somebody who understands. In fact, the simili-pro is like one of Mr. Rafter's nice examples. The only thing the simili-pro understands is how to dupe his customers.

The reading of FX forums is a 4th dimension experience. The customer's innocence/ignorance/unwillingness to try to understand/learn/look seems without limits. At the retail level, there are few attempts to know the market, the brokers, who are the players, what is the leverage, the spread, etc. It seems like people want deliberately to play blindly. When they buy a piece of fish at the fish market, they will carefully compare, weigh, smell, touch, remember, etc. When they buy 10,000 euros with leverage 10, they will base it on two crossing lines from a surrealist Picasso like painting.

It is not so hard to quantitatively verify that a great part of the losses is not due to the market, but to the broker. People focus on the market (even completely wrongly), while the real play is not there. A great percent of trades/plays don't happen at the market level, but stay intra broker. (Hence, if you want to make money, you'll strongly have to make it from your broker, and not from the market. That's a rather different game.)

Despite all the above remarks, I found the FX a very nice teaching and training field. Since the broker's big obstacle, an oligopoly, etc, searching edges is quite hard. It's thus quite formidable. I do not pretend other markets are marshmallows, but the FX is specific.

May

20

One of the best things that I've done in my own speculative career is to realize that I am a loser in various niches and to exit those forever.

I retired relatively gracefully from squash after losing for only a year or two. I did the same with fixed income, and after a loss with foreign currencies. Vis-à-vis the latter, I concluded that whichever way I traded the market would go the other way — It wasn't so much a matter of running my stops and taking advantage of my fixed decision making, it was more a matter of the banks making say 300 billion a year from the markets. How in the world is there going to be enough money left over for me to make?

I shudder at how active and how good one has to be at something just to try to stay above water. I would urge all who trade the markets to periodically stop and think whether they have an edge. They should decide if they've made money, taking into consideration all their bad luck and the rule of ever-changing cycles.

The market loves to let you make money on small capital (like they did with the trend followers and so many hedge funds) just so you invest humongous amounts on 'the system that can't fail', only to take you for billions later on.

But of course the rate of return is still positive, and the manager still has 50% of the fund that he owns, since he takes out the fees monthly — the customer takes the losses on the big capital.

If only managers and customers were more humble, more willing to admit that they are guaranteed to lose in certain niches, the public would lose so much less than they have to. Moreover, the world of markets would be a much healthier place, and we would have fewer poseurs and flimflam artists in our midst.

Mark Goulston comments:

This post makes a great point. Here are a couple reasons why people don't cut their losses.

If as right as you thought you were is as wrong as you turned out to be, the fear is that you could be wrong about lots of things.

People confuse making a mistake with being a loser. If, however, you see every loss as a mistake and learn the lesson it teaches, you never have to view losses as a failures, just as lessons.

A friend of mine, Jason Calacanis, who has made and lost lots of money in Internet ventures, told me that if you make a decision that turns out to be dead wrong, recognize it when it is obvious, change direction, and never make the same mistake again. Then you'll be better off than 90% of people.

Steve Leslie adds:

One of the great lessons in poker is that it is a game of imperfect information. Therefore you have only so much to go on. And you have a very limited time to make decisions, never more than a minute or two at the very most. Now in no limit hold-em this can be a decision that can end your tournament hopes or advance you to the championship.

Once you make your decision there is no going back. You can call, raise, or fold. That is it. And all decisions are binding. Just like trading.

After playing serious poker for a decade, I have made many incorrect decisions. I have also made plenty of correct decisions. But I think I have made more correct ones that wrong ones.

My goal every time I sit at a table is to try and play each individual hand as correctly as I can. Once I decide to play a hand I try to conjure up energy in my mind to focus exclusively on this event, to attack with laser like focus, eliminate as many distractions as possible, and to play within myself. That is all anyone can expect in the game of poker. The rest is a result of mathematics, statistics, and luck or variance. Sometimes you win; sometimes you lose. But unlike baseball you never get rained out. And you accept the outcome.

Finally, after these many years, I believe that my first impression of the correct play is the best one. After observing, calculating odds and my bet, I go with my initial decision. I do not try to talk myself into something else. It may not be the one, but it is the clearest one, the one that has the best vision, at least in my view. And this is the one that counts.

There are plenty of coulda, woulda, shoulda's, but after all it is all part of the game. If it were easy, then everybody would do it and they would be good at it and there would be no value left, or exploitation, or need to try to get better.

Just like trading.

From Dylan Distasio:

I firmly believe that there is a meal for a lifetime in this post. Even with an edge, beating any particular market average over the long term is an incredibly difficult proposition. Without an edge, it becomes impossible.

Besides gauging the dynamics of a particular market, and examining your edge through experience, knowledge, or other empirical means, I think it's also critical to examine whether a particular style or timeframe of trading agrees with your personality and psychology.

As an example, some people are able to thrive in an intra-day environment, whereas others due to psychological makeup alone may not be suited for this pace of trading despite having the informational tools available to make a go at it.

There are a myriad of timeframes, markets, and methods of trading out there. Finding one that suits you from both an empirical edge and a psychological edge is your best chance at finding long-term success.

The psychological edge, I believe, becomes extremely important during the inevitable draw downs, mistakes, and bad luck that accompany all trading.

Alan Millhone writes:

Would there be any fund managers who would honestly admit in public that they are not making money? The Chair makes a well-founded point for a person to leave alone areas where they are not familiar. I try to stay with areas where I have some knowledge and familiarity. In construction we have two major hospital additions going up as I type. This type of commercial work is out of my realm. I don't have the crew, equipment, or bonding capability to ever consider undertaking such projects.

As Clint Eastwood says, "Man's got to know his limitations." This holds true in the market and with about any other undertaking we can envision in life. Years back I did a lot of work for a local oil and gas business. It was interesting to watch them pour over a map of an area and decide where to drill and then go out and find investors. I think I could have pinned the map to a wall and thrown darts at it and been just as accurate. The owner once told me the definition of an oil well. He said it was a hole in the ground with a bunch of liars standing around the hole looking down into it!

May

20

Collectibles are fun to work with, and the value appreciation just seems to come along for the ride as you sit on what you have over the long haul. In 1958 my parents gave me two sets of Lionel trains for Christmas. They are safely housed in my father's World War II army footlocker. Both sets of trains are still in their original boxes. The boxes are worth as much as the trains in today's collectible market.

What stocks to buy and hold? As a non-trader if I were looking, I would see what kind of salaries, perks, etc., the companies paid executives. In today's world I would lean towards energy stocks, as I don't see gasoline or utilities going down anytime soon.

May

19

"Reasonable people adapt themselves to the world. Unreasonable people attempt to adapt the world to themselves. All progress, therefore, depends on unreasonable people." - Shaw

Frame of reference is critical. We may go beyond the idea of the quote above by considering the viewpoints and knowledge of those involved. I am talking about more than the old lion phenomenon, where the old lions hate their younger successors and rehash the ideas of the past.

What if the problem can be solved through application of concepts foreign to the people in the discipline? Crackpots fail because they search for their new ideas too far into the wilderness. The Chair is one who exemplifies the search for useful new concepts in the knowledge of other disciplines. I recently built an effective combined experimental and computational model for a toxicology problem that the toxicologists said couldn't possibly work. They owe me a beer because their frame of reference (standard toxicology) was wrong for the problem, when my frame of reference (spectroscopy and computational modeling) easily explained what was happening.

May

19

The point of having 'will to win' is not to intimidate the opponent but rather heighten one's own motivation, awareness, speed of thought (pattern synthesis) and be able to withstand the pain. I don't think someone can do this well when they're a cold fish. You've got to be 'on fire' to achieve these higher levels of brain function. This is very clear to the fraternity of chess Grandmasters, who tend to discover all sorts of errors in their homework when they're actually sitting at the board in combat.

What enables people to achieve such levels of concentration will vary from person to person; Korchnoi found it was good to hate his opponents. For Fischer I believe it was some kind of sadistic impulse ('I like to crush the other guy's ego').

Not everyone accepts the idea of day trading being a cold intellectual exercise, and quite rightly in my view. Maybe long-term traders and investors can afford to be more aloof. But for good day traders (and chess players) I believe 'aloofness' will be much more the exception than the rule. This is certainly the case amongst people from both fields that I know. The whole brain is needed for tough challenges like day trading, not some lobotomized part of it.

Adam Robinson writes:

I couldn't agree more with Nigel's point.

That heightened emotions can enhance one's cognitive awareness and "power" is well known. As organisms, we are Darwinian beneficiaries whose higher functioning is galvanized by the presence of danger, when adrenaline kicks off a cascade of cognitive and physiological responses.

Moreover, the pure absence of emotion in thinking, as in the complete detachment epitomized by Spock in the original Star Trek series, is demonstrated to be a mistaken ideal by Damasio in his book "Descartes Error" (highly recommended). But. . .

Although a mammal's (trader's) neural and synaptic functioning are accelerated by adrenaline, the field of cognitive awareness is narrowed, leading to potential errors. (In the presence of a potential danger, a mammal focuses on the perceived threat, to the practical exclusion of everything else.)

Emotions may better serve a trader in the discovery of a trading system than in its application. Is it not a goal to trade by a system?

It is well-documented in the history of science that, while heightened emotions are necessary in the "incubation" stage of scientific discovery, that the actual discoveries come when one is relaxed, usually out of the blue (the famous BBB phenomenon is bed, bath, bus — the last being an alliterative proxy for walking or travel).

In my former field, in which I dedicated several decades to pondering optimal brain functioning, I have yet to work out the extent to which intelligence tests measure intelligence versus measure "the will to win" (i.e., solve a problem or answer a question).

From Henry Carstens:

Hmmm….

Trading Firm 1 is filled with discretionary traders. They have back-tested their ideas and have a defined edge which they trade each day with discretion. Traders do additional research on nights and weekends.

Trading Firm 2 is filled with discretionary traders and mechanical systems derived from each trader. Each trader's ideas have been back-tested and their edges defined. Firm 2 uses each trader's mechanical edge as a baseline to monitor their performance, to forecast the performance of the firm, and to create realistic risk and capital allocation controls. When a trader goes on vacation, has a new idea to test, or retires, that trader's mechanical system is substituted for the trader so the firm suffers no downtime.

Trading Firm 3 is filled with computers and researchers. Each researcher builds out all the viable trades in a time frame, mechanizes the rules, and moves onto a new time frame in the same or a new market. Incoming researchers are handed existing systems to maintain and improve before getting their own timeframes to build out. Each system has built in monitoring code that alerts the risk department when it has moved outside normal parameters.

Then,

Which trading firm has the least overall risk?

Which trading firm is most likely to evolve with the markets?

Which trading firm is least subject to ever-changing cycles?

What is the growth curve likely to look like for each of these firms?

Nigel Davies adds:

In my mid 20s I learned some methods for systematically relaxing during a chess game because my 'nerves' were often getting the better of me and leading to errors during the later stages of a game. This became more or less automatic over time.

Whilst trading I find that a similar 'controlled intensity' works best, though usually at lower levels than in chess, depending on the state of the market. I think that in both fields the focus may well be on 'perceived threats', but I think that one can learn what to look for via research or experience.

It may be just me but I find any attempt to conduct research whilst trading to be an exercise in futility, not to mention very distracting. It is much better to do it beforehand and have an armory of trading patterns ready prepared.

Research during a chess game would of course be illegal, but I think the effect would be the same - no benefit and plenty of distraction. I even found the Blumenfeld rule (writing down the move before playing it) to be very distracting, though now I've been saved from the temptation because they've made that illegal too (relying on 'notes' apparently).

So this paragraph kind of tallies with my own experience. But my take on it is that adrenaline levels can be controlled by the combat veteran and that any narrowing of cognitive awareness isn't a problem as long as someone has the most important things 'hard wired' via training.

George Zachar writes:

Did Einstein have the will to win? Feynman? What about Mises and Hayek? Palindrome? Chair?

My barstool analysis is that humans have too many personality facets, too many parameters of success, and too many life tracks to allow for broad, empirical rules in this sphere.

Looking in the mirror, I see aspects of my life where I am a complete failure and aspects where I have succeeded beyond my wildest dreams, having marshaled the same intellect and will throughout.

From Stefan Jovanovich:

Ian Deary's book Intelligence is the best thing I have read on a subject. Deary's position is that (1) yes, there are measurable qualities in human beings that relate to the brain's ability to calculate, (2) the word "intelligence" is the shorthand description people have decided to use to describe this trait (hence I.Q. tests), and (3) as a measure of human capacity I.Q. tests alone are relatively feeble because living is far more complex than calculation.

I continue to trust my Dad's opinion about this. He was shrewd enough to foresee that standardized testing (MCAT, SAT, etc.) and test cramming (Princeton Review, etc.) would be growth businesses well before any other American or European publisher did. He was also someone who understood the limitations of what he did to make money. He thought there were two problems with intelligence testing. The first was that everyone who fell below the 95th percentile - and their parents - ended up hating the test. The second problem was that neither schools nor teachers nor publishers were honest about telling the students and teachers the truth about how limited standardized tests were.

His solution to both problems was to expand testing so that it measured the entire range of human capabilities - spatial orientation, dexterity, honesty (yes, honesty), mechanical aptitude, and all the other skills and abilities for which actual quantitative testing had been developed. That would confirm what people intuitively knew - that straight A students did not automatically rule the world; and allow schooling to be of value to all students.

It would identify each student's strengths and weaknesses so that - ideally - the student, his or her parents, and teachers, could all work towards diminishing the weaknesses and improving on the strengths. Dad believed that everyone could learn to do better. It was not just a matter of faith. He knew that, even in the area of I.Q. testing, repeated drill and practice worked. Students could improve their scores by almost an entire standard deviation simply by taking an I.Q. test every 3 months instead of only once or twice in their entire schooling. Drill and practice worked. The reason it fell out of disfavor was simple; it was hard work for both the teachers and the students.

Nigel Davies adds:

I'm sure discretionary traders would do badly. But a key factor here is the state of the human material the firms start out with, and even the ancient Hagakure notes falling standards in manhood:

"… [W]hen one comes to speak of kaishaku, it has become and age of men who are prudent and clever at making excuses. Forty or fifty years ago, when such things as matanuki were mainly considered manly, a man wouldn't show an unscarred thigh to his fellows, so he would pierce it himself.

"All of man's work is a bloody business. That fact, today, is considered foolish, affairs are finished cleverly with words alone, and jobs that require effort are avoided. I would like young men to have some understanding of this."

May

19

The recent nine weeks in stocks have been rather bullish. Since the week of 3/12/07 when the S&P was 1387, we are up 9.8%. How does this rank historically? Going back to 1950 and ranking returns of (overlapping) 9 week periods (closes=Fridays), the current run is in the top 6.5% (93rd percentile).

Strong up-runs are neutral short-term: Weeks following those up >8% (90th percentile) test equal to all weeks (this since 1980):

May

19

The high concentration of crackpots amongst scientists helps explain the weak/poor correlation between testable IQ and financial success. What is posited to be more important than facility with tensor calculus is the ability to rank theories as to reasonableness, especially in relation to the nature of human incentives and immutable emotional non-linearity.

May

19

I have been thinking about the performance of companies in crisis. Often crisis is a time of great growth, as often companies in crisis are tarred by the unethical activities of some executive but the basis capital structure and earning power of the business is not affected. Some examples of this are AIG and Tyco, and many of the companies tarred by the back-stating of options, as well as the few companies on the NYSE, where an executive seems to have been too greedy.

There are some million cites on Google for "Crisis" NYSE, and it would be hard to test the overall systematic tendencies and performance of these companies. There is a Delahave index of corporate reputation, which publishes a list of the reputations of the 100 largest NYSE companies. Companies with very bad reputations as of year-end 2006 (with their 2007 performance in parenthesis) include Fannie MAE (+10%), Allstate (-3%), and FORD (+15%).

It would stand to reason that the companies with the worst reputations should have the highest risk premia, and the best should have the lowest.

Another aspect would be the regression bias factor of bad and good reputations being inordinately due to ephemeral factors.

The whole subject calls for a systematic meal for a life time study. See this article on the Delahave Reputation Index is a must read.

Alston Mabry adds:

But reversalists can take heart in the CS/Tremont Hedge Index, which shows that the most successful category in the long run has been Event Driven/Distressed. Optimists can also derive intense pleasure from the worst performer on the list: Dedicated Short Bias.

Nigel Davies adds:

There is a phenomenon in competitive games whereby under-performing participants will outperform in order to reach the standing that accords with their belief about their 'status'. Alternatively, over-performers often find ways to scuttle their own performance in order to reach the comfort of what everyone expects of them. For older players this is the main problem on the road to improvement. The young tend to be immune from such effects as they have yet to 'discover their place'.

I wonder if this same effect is seen in the corporate world, with companies that slip from grace fighting like tigers to recover the status that they believe they deserve. On the other hand, young upstart operations (Google comes to mind) will not know their limits and can leave more respectable rivals in the dust.

May

19

Many of you are going through the graduation celebration season with a son or daughter. I recently had the chance to attend a state gathering of 500 of what is arguably the smartest seventh grade in OK. My seventh grade daughter got state recognition for her ACT reading score, and almost qualified for the science score through Duke TIPS program.

This program has taken off and is highly pushed by both public and private Jr. High schools in OK as a means to distinguish bragging rights for the educators as well as the parents.

Besides the above-mentioned 500 students about 50 students qualified for national recognition. While state recognition standard is near about the top 1% of seventh graders taking the test to qualify for national you needed to score near the top 1% for all students taking the test.

This opportunity was the chance to observe the concentration of talent of one age in one place. More than 400 of these honorees attended the ceremonies. It was a wonderful chance to evaluate the top tier of my daughter's peers.

What struck me about this group was how different they were from classmates. This group was even more different than the Hollywood image of what a young smart teen should look like. Notable difference are as follows:

None had the overdone beauty queen want-a-be look. Very few had dyed hair or much hair styling at all. If they did dye, it was an anti-social hair cut. But this was the rarity. The contrast to my daughter's peers at school was significant.

Likewise for the boys there were few if any clear "jocks", boys that towered over their peers by height, strength/weight.

Both the boys and the girls were, well, still boys and girls. Most were clearly budding into puberty but many seemed behind their other peers in physical development. These were pretty kids, but nobody would mistake them for adults.

The Blacks, Hispanics, and Native Americans where clearly under-represented for their population in our state. Yet those that did attend had the large extended families also attending to honor them.

The Asian Indian population was only slightly over-represented, but they were more heavily represented at the national level.

All in all this was a very balanced set of kids. They escaped many of the cultural products that destroy many youths. If you saw the kids you would know how wrong the media's view is of the "youth of today".